Individual income is much more variable than aggregate per capita income. I argue that aggregate information is
therefore not very important for individual consumption decisions and construct a model of life-cycle consumption in
which individuals react optimally to their own income process but ignore economy wide information. Since individual
income is less persistent than aggregate income consumers will react too little to aggregate income variation. Aggregate
consumption will be excessively smooth. Since aggregate information is slowly incorporated into consumption,
aggregate consumption will be autocorrelated and correlated with lagged income. On the other hand, the model has
the same prediction for micro data as the standard permanent income model. I argue that this is roughly in accord with
the findings in the literature.
The second part of the paper provides empirical evidence on individual and aggregate income processes and calibrates
the model using the estimated parameters. The model predictions roughly correspond to the empirical findings for
aggregate consumption. Allowing for the existence of measurement error in micro income, durables, finite lifetimes
of consumers, and advance information improves the predictions of the model. These features introduce relatively
small changes as compared to the impact of incomplete information.

This paper tests the rational expectations lifecycle model of consumption
against (i) a simple Keynesian model and (ii) the rational expectations
lifecycle model with imperfect capital markets. The tests are based upon the
relative responsiveness of consumption to income changes which can be
predicted from past information and income changes which cannot be predicted.
Problems caused by measurement error in the income changes are circumvented by
using the innovations from a vector autoregression of the measures of the
determinants of income to form a noisy instrument for the unanticipated change
in incomfi and using the lagged values of the measures of the income
determinants to form an instrument for the anticipated income change. We show
that the Keynesian model implies that the regression coefficients relating the
change in consumption to the instruments for the anticipated and unanticipated
components of the income change should be equal. The lifecycle model (with
perfect capital markets) implies that only the instrument for the
unanticipated component should affect consumption. The empirical results
support the lifecycle model. In addition, we incorporate capital market
imperfections into our empirical formulation of the lifecycle model by
assuming that the marginal interest rate at a point in time is a
differentiable, concave function of net assets. This leads to a test for
capital market imperfections based upon whether consumption responds
differently to positive and negative predictable changes in income. Our
results are inconclusive.