Use CONSUMP.RAW for this exercise. One version of the permanent income hypothesis (PIH) of consumption is that the growth in consumption is unpredictable. [Another version is that the change in consumption itself is unpredictable; see Mankiw (1994, Chapter 15) for discussion of the PIH.] Let gct = log(ct) - log(ct-1) be the growth in real per capita consumption (of nondurables and services). Then the PIH implies that E(gct) = E(gct), where It-1 denotes information known at time (t - 1); in this case, t denotes a year.
(i) Test the PIH by estimating gct = (0 + (1gct-1,_x + ut. Clearly state the null and alternative hypotheses. What do you conclude?
(ii) To the regression in part (i), add gyt-1 and i3t-1, where gy, is the growth in real per capita disposable income and i3t is the interest rate on three-month T-bills; note that each must be lagged in the regression. Are these two additional variables jointly significant?