Does the Permanent Income Hypothesis Exist in 10 Asian Countries?
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permanent income hypothesis, liquidity constraint, panel cointegration, panel-type ECM
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This paper applies a recent advance in panel analysis to estimate the panel cointegration and panel-type error correction model for a set of ten Asian countries using annual data covering the period …more
This paper applies a recent advance in panel analysis to estimate the panel cointegration and panel-type error correction model for a set of ten Asian countries using annual data covering the period 1950–2006. The study investigates whether the permanent income hypothesis holds true in the ten Asian countries; and whether liquidity constraints affect consumer spending. Our empirical analyses of panel data consist of the following four steps. First, we test for a panel unit root. Second, we test for cointegration among panel data employing the panel cointegration test; and a Fisher-type test using an underlying Johansen methodology. Third, the long-run equilibrium relationship is estimated using the fully modified ordinary least squares technique for heterogeneous cointegrated panels. Finally, once the panel cointegration is established, we establish a panel-type error correction model to further test whether the permanent income hypothesis/life cycle hypothesis is valid. The empirical results show that consumption and current income are strongly cointegrated, liquidity constraints exist in all ten Asian countries, and this implies that the permanent income hypothesis is not upheld. In addition, the effect of the 1997 Asian financial crisis on the size of liquidity constraints is investigated, and the results show that liquidity constraints increased after the Asian financial crisis. The likely explanation of this is that households were not able to smooth their consumption relative to their permanent income through short-term borrowing, as liquidity is tighter and borrowing constraints are stronger. Therefore the financial crisis resulted in consumption levels that are more sensitive to current income levels, and this provides further support against the case for the permanent income hypothesis/life cycle hypothesis, in these countries.