Incomplete information and the time series behaviour of consumption

Pischke (1995) uses both microeconomic and macroeconomic US data to test th e idea that, within an otherwise standard PIH framework, ignorance by agent s of aggregate labour income can account for the observed degree of excess smoothness and sensitivity in consumption. His tests involve only the secon d moments of aggregate consumption and labour income. In this paper our mai n aim is to identify and test the restrictions his model implies for aggreg ate consumption dynamics, using US quarterly data over the period 1959-1996 , but our framework allows us also to test an earlier, related model of Goo dfriend (1992). We find that both models can be formally rejected: ignoranc e of aggregate labour income cannot by itself account for aggregate consump tion dynamics; some other relaxation of the assumptions of the standard PIH is required. We give an example of one possible such relaxation and presen t evidence indicating that Pischke's version of imperfect information may, within that framework, have a significant role to play. Copyright (C) 2000 John Wiley & Sons, Ltd.