The Drifting Influence of Hall's Random-Walk Hypothesis on Consumption Modeling

Abstract

Hall's 1978 article titled “Stochastic Implications of the Life Cycle–Permanent Income Hypothesis” was meant to revolutionize consumption modeling. It indeed delivered, but not by becoming the dominant modeling strategy, but by unleashing a complex process of interaction between researchers in consumption and interconnected fields that transformed Hall's original object, from a local theory of consumption into a growing research area spanning the fields of consumption, finance, monetary policy and econometric modeling, and becoming, at the turn of the century, a building block of the DSGE modeling framework. Researchers reacting to innovative work produced new models that acted modified the context of research inducing a feedback system responsible for a connected set of innovations in the fields mentioned above. Along that process the practice of consumption modeling drifted away from Hall's original proposal, suggesting the necessity of a more nuanced view of the notion of influence in contemporary macroeconomics. In this particular case, we found that drifting occurred within the bounds set by the Euler equation and the assumptions of intertemporal optimization and rational expectations.