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Precautionary saving and the marginal propensity to consume out of permanent income

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  • Carroll, Christopher D.

Abstract

The budget constraint requires that, eventually, consumption must adjust fully to any permanent shock to income. Intuition suggests that, knowing this, optimizing agents will fully adjust their spending immediately upon experiencing a permanent shock. However, this paper shows that if consumers are impatient and are subject to transitory as well as permanent shocks, the optimal marginal propensity to consume out of permanent shocks (the MPCP) is strictly less than one, because buffer-stock savers have a target wealth-to-permanent-income ratio; a positive shock to permanent income moves the ratio below its target, temporarily boosting saving.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 56 (2009)
Issue (Month): 6 (September)
Pages: 780-790

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Handle: RePEc:eee:moneco:v:56:y:2009:i:6:p:780-790

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Web page: http://www.elsevier.com/locate/inca/505566

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Keywords: Risk Uncertainty Consumption Precautionary saving Buffer-stock saving Permanent income hypothesis;

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References

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  1. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
  2. Kjetil Storesletten & Chris Telmer & Amir Yaron, 1997. "Consumption and risk sharing over the life cycle," GSIA Working Papers 228, Carnegie Mellon University, Tepper School of Business.
  3. Carroll, Christopher D & Kimball, Miles S, 1996. "On the Concavity of the Consumption Function," Econometrica, Econometric Society, vol. 64(4), pages 981-92, July.
  4. Christopher D. Carroll & Miles S. Kimball, 2001. "Liquidity Constraints and Precautionary Saving," NBER Working Papers 8496, National Bureau of Economic Research, Inc.
  5. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  6. Angus Deaton, 1989. "Saving and Liquidity Constraints," NBER Working Papers 3196, National Bureau of Economic Research, Inc.
  7. Tullio Jappelli & Luigi Pistaferri, 2004. "Intertemporal choice and consumption mobility," 2004 Meeting Papers 195, Society for Economic Dynamics.
  8. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244.
  9. John M. Abowd & David Card, 1986. "On the Covariance Structure of Earnings and Hours Changes," NBER Working Papers 1832, National Bureau of Economic Research, Inc.
  10. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
  11. Richard Blundell & Hamish Low & Ian Preston, 2013. "Decomposing changes in income risk using consumption data," Quantitative Economics, Econometric Society, vol. 4(1), pages 1-37, 03.
  12. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  13. David S. Johnson & Jonathan A. Parker & Nicholas S. Souleles, 2004. "Household Expenditure and the Income Tax Rebates of 2001," NBER Working Papers 10784, National Bureau of Economic Research, Inc.
  14. Miles S. Kimball, 1990. "Precautionary Saving and the Marginal Propensity to Consume," NBER Working Papers 3403, National Bureau of Economic Research, Inc.
  15. Carroll, Christopher D., 2011. "Theoretical foundations of buffer stock saving," CFS Working Paper Series 2011/15, Center for Financial Studies (CFS).
  16. Christopher D. Carroll, 2001. "A Theory of the Consumption Function, With and Without Liquidity Constraints (Expanded Version)," NBER Working Papers 8387, National Bureau of Economic Research, Inc.
  17. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
  18. Caballero, R.J., 1988. "Consumption Puzzles And Precautionary Savings," Discussion Papers 1988_05, Columbia University, Department of Economics.
  19. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1.
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