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Precautionary Saving and the Marginal Propensity To Consume Out of Permanent Income

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  • Christopher D Carroll

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 1, 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

Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 445.

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Date of creation: Mar 2001
Date of revision: Aug 2009
Handle: RePEc:jhu:papers:445

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  1. Caballero, Ricardo J., 1990. "Consumption puzzles and precautionary savings," Journal of Monetary Economics, Elsevier, Elsevier, vol. 25(1), pages 113-136, January.
  2. Tullio Jappelli & Luigi Pistaferri, 2004. "Intertemporal choice and consumption mobility," 2004 Meeting Papers 195, Society for Economic Dynamics.
  3. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198288244, October.
  4. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  5. 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.
  6. Richard Blundell & Hamish Low & Ian Preston, 2013. "Decomposing changes in income risk using consumption data," Quantitative Economics, Econometric Society, Econometric Society, vol. 4(1), pages 1-37, 03.
  7. Christopher Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," NBER Working Papers 10867, National Bureau of Economic Research, Inc.
  8. Christopher D. Carroll & Miles S. Kimball, 1995. "On the concavity of the consumption function," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 95-10, Board of Governors of the Federal Reserve System (U.S.).
  9. 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, Elsevier, vol. 18(1), pages 83-114, January.
  10. Christopher D. Carroll, 2001. "A Theory of the Consumption Function, with and without Liquidity Constraints," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 23-45, Summer.
  11. Christopher D. Carroll & Miles S. Kimball, 2001. "Liquidity Constraints and Precautionary Saving," NBER Working Papers 8496, National Bureau of Economic Research, Inc.
  12. 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.
  13. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2000. "Consumption and Risk Sharing Over the Life Cycle," NBER Working Papers 7995, National Bureau of Economic Research, Inc.
  14. 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.
  15. Angus Deaton, 1989. "Saving and Liquidity Constraints," NBER Working Papers 3196, National Bureau of Economic Research, Inc.
  16. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
  17. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, October.
  18. Nicholas S. Souleles & Jonathan A. Parker & David S. Johnson, 2006. "Household Expenditure and the Income Tax Rebates of 2001," American Economic Review, American Economic Association, vol. 96(5), pages 1589-1610, December.
  19. Miles S. Kimball, 1990. "Precautionary Saving and the Marginal Propensity to Consume," NBER Working Papers 3403, National Bureau of Economic Research, Inc.
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