How does Household Consumption Respond to Income Shocks?

We then explore whether a simple partial equilibrium Friedman-style permanent income model is consistent with the empirical facts. Our preliminary findings suggest that the PIH model provides a reasonably good approximation of the facts in the data, but only if transitory income shocks are the predominant source of income changes and if measurement error in income is substantial. We conclude, however, that an explicit model of housing is required to rationalize the strong co-movement of income and real estate wealth.