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A re-examination of the excess smoothness puzzle when consumers estimate the income process

Banerjee, A.N.; Basu, P.

Authors

P. Basu



Abstract

The excess smoothness puzzle is explored using a simple version of the permanent income hypothesis. The new feature is that consumers do not know the observed data-generating process for income. Instead they estimate the income process every period using the past income data and update their income forecasts as new data arrive. Two scenarios are examined: first, where the income has a linear deterministic trend and second, where the income has a constant trend. There is a misspecification bias in the estimate of the marginal propensity to consume (MPC). This bias is of second-order importance in the first scenario while it is of first-order importance in the second. We conclude that the second scenario, which may be relevant for less developed countries, may offer a potential solution to the excess smoothness puzzle.

Citation

Banerjee, A., & Basu, P. (2001). A re-examination of the excess smoothness puzzle when consumers estimate the income process. Journal of Forecasting, 20(5), 357-366. https://doi.org/10.1002/for.796

Journal Article Type Article
Publication Date 2001-08
Deposit Date Aug 27, 2008
Journal Journal of Forecasting
Print ISSN 0277-6693
Electronic ISSN 1099-131X
Publisher Wiley
Peer Reviewed Peer Reviewed
Volume 20
Issue 5
Pages 357-366
DOI https://doi.org/10.1002/for.796
Keywords Sensitivity, Consumption, Excess smoothness forecast.
Public URL https://durham-repository.worktribe.com/output/1596578


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