Journal of Political Economy · 1978 · 675 citations · 0 references
Social SciencesBusiness EconomicsEconomicsConsumption StudiesMacroeconomicsMicroeconomicsConsumer TheoryConsumption PatternsDynamic Economic ModelsHousehold ConsumptionHousehold EconomicsTime Series EconometricsConsumption ProcessesConsumption-saving ModelsHousehold Consumption DynamicsIntertemporal Consumption ChoiceLife-cycle ConsumptionLife-cycle Household EconomicsPermanent Income HypothesisRandom Walk Hypothesis
Consumer optimization implies that marginal utility of consumption follows a random walk with trend. The study tests this implication using postwar United States time‑series data. The authors analyze real disposable income and stock price indices to assess predictive power for consumption. Consumption behaves as a random walk, with no variable beyond current consumption predicting future consumption; real disposable income confirms this while stock prices do not, supporting a modified life‑cycle permanent‑income hypothesis.
Optimization of the part of consumers is shown to imply that the marginal utility of consumption evolves according to a random walk with trend. To a reasonable approximation, consumption itself should evolve in the same way. In particular, no variable apart from current consumption should be of any value in predicting future consumption. This implication is tested with time-series data for the postwar United States. It is confirmed for real disposable income, which has no predictive power for consumption, but rejected for an index of stock prices. The paper concludes that the evidence supports a modified version of the life cycle--permanent income hypothesis.