FINANCIAL LIBERALIZATION AND THE PERMANENT INCOME HYPOTHESIS*

Abstract

This paper addresses the question of whether financial liberalization and innovation have significantly altered consumption behavior by reducing liquidity constraints as capital markets become more flexible. A consumption model, in which the permanent income hypothesis and extreme Keynesian consumption functions are nested as special cases, is the starting point for this analysis. Estimated values for the sensitivity of consumption to current income for different time periods and for several OECD countries are assessed. These results are then compared in the light of their various econometric properties, country-specific liberalization measures, and a variety of proxies reflecting changing liquidity constraints. Copyright 1995 by Blackwell Publishers Ltd and The Victoria University of Manchester