Direct tests of the permanent income hypothesis under uncertainty, inflationary expectations and liquidity constraints

Several studies have argued that the life-cycle permanent income hypothesis (LC-PIH) of Hall (1978) breaks down because of the excess sensitivity of c onsumption to current income and through consumers failing to exploit infor mation which is available in period t-1. Using direct expectations data bas ed on consumer surveys for the U.S., this study shows that when uncertainty , in particular, and credit constraints are accommodated in the model, cons umption is not sensitive to current income. Moreover, contrary to previous empirical findings, the index of consumer confidence is found to be unable to predict consumption. Thus, the theoretical predictions of the rational e xpectations LC-PIH are unfounded empirically because they fail to accommoda te uncertainty, in particular, and credit constraints.