Output, Consumption and Investment in the Permanent Income Hypothesis

This paper analyzes the contribution of supply and demand shocks to the fluctuations of a stochastically growing economy where consumption is governed by the PIH model with transitory consumption. U.S. empirical evidence shows that demand shocks play a dominant role in explaining the overall fluctuations of output, the fluctuations of consumption are well explained by both shocks, and the movement of net investment is explained primarily by demand shocks. The empirical findings of consumption emphasize the importance of transitory consumption in the consumption process.