ABSTRACT

On the Relationships between Real Consumption, Income, and Wealth (Journal of Business and Economic Statistics, January 2006, with Michael Palumbo and Jeremy Rudd).

Structural regressions relating real consumption of nondurables and services to real income and wealth play an important role in macroeconomics. In traditional analyses, real income and wealth are measured by deflating with a price index for total consumption expenditures. We show that this procedure is only valid under the assumption that real consumption of nondurables and services is a constant multiple of aggregate real consumption outlays - an assumption that represents a very poor description of U.S. data. We develop an alternative approach that is based on the observation that the ratio of these series has historically been stable in nominal terms. We demonstrate that the choice of deflation methodology has important implications for the assessment of the effects of wealth on consumption and for tests of predictions of the permanent income hypothesis.