Pitfall of simple permanent income hypothesis model

Permanent Income Hypothesis (hereafter, PIH) is one of the central concepts in macroeconomics. Single equation version of PIH is often appeared in textbooks and academic papers. But, even in single equation version of PIH Romer(2006) suggested, to get economic insights from estimation, we need to consider the additional income determination equation and then we can't ignore “Simultaneous equations bias.†In this note, we examine this “Simultaneous equations bias†effect theoretically and empirically. Our results suggest that ignoring this bias will lead to the wrong estimates and conclusion. More attention should be given on simultaneous equations approach.