On the Relationships Between Real Consumption, Income, and Wealth

Abstract

Many studies relate real nondurables and services consumption to real income and wealth, with the latter measures obtained by deflating with a price index for total consumption expenditures. This procedure is appropriate only if real nondurables and services consumption is a constant multiple of aggregate real consumption outlays, which is not the case in U.S. data. We develop an alternative approach that exploits the fact that the ratio of these series has historically been stable in nominal terms, and demonstrate that the choice of deflation methodology has important implications for wealth effect estimation and tests of the permanent income hypothesis.

KEY WORDS:

• Budget constraints
• Permanent income hypothesis
• Price deflation
• Wealth effects