The dynamic effects of permanent and transitory labor income on consumption

This paper formulates a version of the permanent income hypothesis in which households decompose labor income into permanent and transitory components to determine the allocation of disposable income into permanent consumption, transitory consumption, and saving. A procedure is developed based on this model to empirically identify these components of labor income and the effects of their innovations on consumption. The procedure, which is closely related to the Blanchard and Quah, Journal 79, 655-693 1989 approach, is applied to study US post-World War II time-series data. (C) 1998 Elsevier Science B.V. All rights reserved.