Empirical Tests of the Rational Expectations - Permanent Income Hypothesis: Evidence from Pakistan

Ahmad H. Khalid


The permanent income hypothesis postulates that at a given
point in time, an individual's consumption is determined by his lifetime
resources and not by his income. Thus, the hypothesis suggests that an
individual's consumption will respond only to changes in permanent
income. The insertion of the rational expectations theory into
Friedman's permanent income hypothesis by Hall (1978),-called the
Rational Expectations/Permanent Income Hypothesis (thereafter
RE/PIH)changed this view, and suggested that current aggregate
consumption is determined only by its own lag. Any information that may
help in determining current consumption is already included in last
period's consumption. Hence consumption follows a random walk. The
testable implication of Hall's hypothesis is that apart from the current
period's consumption expenditure, any variable observable in this or
earlier periods should not show any predictive power for the next
period's consumption expenditure. Therefore, additional lagged values of
consumption or any other variable that can reasonably be assumed to be
in the consumer's information set at time t should not be statistically
significant if regressed over current consumption.

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DOI: https://doi.org/10.30541/v33i4IIpp.1043-1053


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