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The relative income hypothesis

  • Alvarez-Cuadrado, Francisco
  • Van Long, Ngo

Despite its theoretical dominance, the empirical case in favor of the permanent income hypothesis is weak. Contrary to one of its basic implications, a growing body of evidence suggests that rich households save a higher proportion of their permanent income than poor households. We propose an overlapping-generations economy where households care about relative consumption. As a result, an individual's consumption is driven by the comparison of his lifetime income and the lifetime income of his reference group; a permanent income version of Duesenberry's (1949) relative income hypothesis. Across households the savings rate increases with income while aggregate savings are independent of the income distribution.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 9 (September)
Pages: 1489-1501

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:9:p:1489-1501
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