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The Life Cycle Hypothesis and Rational Expectations: Some Further Empirical Results

Published online by Cambridge University Press:  17 August 2016

R. MacDonald  and
D.A. Peel
R. MacDonald
Affiliation:
(University of Aberdeen)
D.A. Peel
Affiliation:
(University of Aberystwyth)
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Extract

In an innovative and important paper Hall (1978) demonstrated that the assumption of rational expectations when applied to the life cycle or permanent income hypothesis would, given a number of further assumptions such as constancy of the real rate of interest, imply that real consumption follows a martingale. Thus in logarithms

log C - log C- 1 = α + ∊

where C is real consumer expenditure, α is a constant which allows for real growth in the economy and ∊ is a white noise error term.

Hall presented empirical evidence for the U.S. economy which was broadly consistent with the hypothesis. However, subsequent work by a number of authors (eg Muellbauer (1983) and Hendry and von Ungern-Sternberg (1980)) appears to be inconsistent with the hypothesis. Past values of economic variables, such as consumption or income, are significant determinants of the first difference of the logarithm of consumption which violates the hypothesis.

Type
Research Article
Information
Recherches Économiques de Louvain/ Louvain Economic Review , Volume 49 , Issue 4 , December 1983 , pp. 381 - 390
Copyright
Copyright © Université catholique de Louvain, Institut de recherches économiques et sociales 1983 

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References

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