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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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8233.

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Date of creation: Apr 2001
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Publication status: published as Christopher D. Carroll, 2001. "Mathematica code for Precautionary Saving and the Marginal Propensity to Consume out of Permanent Income," QM&RBC Codes 39, Quantitative Macroeconomics & Real Business Cycles.
Handle: RePEc:nbr:nberwo:8233

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  1. Kjetil Storesletten & Chris Telmer & Amir Yaron, 1997. "Consumption and risk sharing over the life cycle," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 228, Carnegie Mellon University, Tepper School of Business.
  2. Caballero, Ricardo J., 1990. "Consumption puzzles and precautionary savings," Journal of Monetary Economics, Elsevier, Elsevier, vol. 25(1), pages 113-136, January.
  3. Jappelli, Tullio & Pistaferri, Luigi, 2005. "Intertemporal choice and consumption mobility," CFS Working Paper Series 2005/28, Center for Financial Studies (CFS).
  4. 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.
  5. Carroll, Christopher D., 2011. "Theoretical foundations of buffer stock saving," CFS Working Paper Series 2011/15, Center for Financial Studies (CFS).
  6. 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.).
  7. 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.
  8. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198288244, October.
  9. 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.
  10. Christopher D. Carroll & Miles S. Kimball, 2001. "Liquidity Constraints and Precautionary Saving," NBER Working Papers 8496, National Bureau of Economic Research, Inc.
  11. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  12. 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.
  13. Carroll, Christopher D. & Samwick, Andrew A., 1997. "The nature of precautionary wealth," Journal of Monetary Economics, Elsevier, Elsevier, vol. 40(1), pages 41-71, September.
  14. 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.
  15. Miles S. Kimball, 1990. "Precautionary Saving and the Marginal Propensity to Consume," NBER Working Papers 3403, National Bureau of Economic Research, Inc.
  16. Deaton, A., 1989. "Saving And Liquidity Constraints," Papers, Princeton, Woodrow Wilson School - Public and International Affairs 153, Princeton, Woodrow Wilson School - Public and International Affairs.
  17. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, January.
  18. 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.
  19. 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.
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