Household Production and the Excess Sensitivity of Consumption to Current Income

Marianne Baxter; Urban J. Jermann

doi:10.1257/aer.89.4.902

American Economic Review Vol. 89 No. 4 1999

Household Production and the Excess Sensitivity of Consumption to Current Income

Marianne Baxter¹; Urban J. Jermann²

¹ Department of Economics, Rouss Hall 116, University of Virginia, Charlottesville, VA 22901. · ² Department of Finance, 2327 Steinberg-Dietrich Hall, The Wharton School, University of Pennsylvania, 3620 Locust Walk, Philadelphia, PA 19104.

Abstract

Empirical research on the permanent-income hypothesis (PIH) has found that consumption growth is excessively sensitive to predictable changes in income. This finding is interpreted as strong evidence against the PIH. We propose an explanation for apparent excess sensitivity that is based on a quantitative equilibrium model of household production in which permanent-income consumers respond to shifts in sectoral wages and prices by substituting work effort and consumption across home and market sectors. Although the PIH is true, this mechanism generates apparent excess sensitivity because market consumption responds to predictable income growth.

DOI: 10.1257/aer.89.4.902
Volume: 89
Issue: 4
Pages: 902-920
Language: en
Sources: bibtex:phds-export.bib openalex openalex crossref

Household Production and the Excess Sensitivity of Consumption to Current Income

Abstract

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