The Time Series Consumption Function: Error Correction, Random Walk and the Steady-State

Abstract

This paper examines, and attempts to reconcile, two rival approaches toward modeling the aggregate time series consumption function: the random walk and the error correction models. These models possess conflicting behavioral interpretations, but have been extensively used in the empirical literature. The paper modifies the life-cycle theory to generate a more satisfactory long-run relationship that demonstrates that the time series data on personal consumption and wealth are likely to have an error correction representation that encompasses the random walk model. Data from the United Kingdom support this proposition. Copyright 1991 by Royal Economic Society.