TESTING THE PERMANENT INCOME HYPOTHESIS - THE IRISH EVIDENCE

We investigate whether the permanent income hypothesis (PIH) is consistent with Irish data and find that it holds for about 50 per cent of consumers. We hypothesise that worsening borrowing conditions lead agents to consume more out of disposable income and this causes the PIH to be refuted empirically. We hypothesise that the economy consists of two types of optimising consumers. One type are creditors who behave in a standard fashion. The other type are borrowers who are liquidity constrained and face a schedule of loan interest rates which are an increasing function of the amount of the loan. Our results confirm our hypothesis and indicate that when borrowing conditions worsen consumption growth becomes more responsive to income and less responsive to interest rates.