A Reexamination of Friedman's Consumption Puzzle |
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Authors: | James H Stock |
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Institution: | Kennedy School of Government, Harvard University , Cambridge , MA , 02138 |
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Abstract: | The different average and marginal consumption propensities estimated from time series data constitute a classic puzzle of the theory of consumption. This article argues that if consumption and income possess a common stochastic trend (and thus are cointegrated), both the average propensity to consume (APC) and the marginal propensity to consume (MPC) will be consistent but biased in small samples. Upon correcting for this small sample bias, the puzzling discrepancies between the APC and the MPC estimated using annual data for the United States from 1897 to 1949 become substantially smaller. This supports an alternative resolution of the puzzle based on the theory of cointegration. |
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Keywords: | Cointegration Error correction Finite-sample bias |
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