Permanent Income, Current Income and Consumption: Evidence from Two Panel Data Sets

In this paper, the author estimates Euler equations, i.e., the first order conditions of the consumers’ maximization problem, using data from two data sets. Consumption data are taken from the Consumer Expenditure Survey. Income data are taken from the Panel Study of Income Dynamics. Since the data for the estimation come from two samples, the author uses a generalization of the instrumental variables estimator: two-sample instrumental variables estimator. She finds evidence that consumption is excessively sensitive to predictable income growth. The estimates of the coefficient of excess sensitivity for three consumption measures range from 0.2 to 0.5.