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

  • Carroll, Christopher D.

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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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
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. 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.
  2. David S. Johnson & Jonathan A. Parker & Nicholas S. Souleles, 2004. "Household Expenditure and the Income Tax Rebates of 2001," Working Papers 136, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics..
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  4. Christopher D. Carroll, 2009. "Theoretical Foundations of Buffer Stock Saving," 2009 Meeting Papers 210, Society for Economic Dynamics.
  5. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  6. Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2002. "Consumption and Risk Sharing Over the Life Cycle," Seminar Papers 702, Stockholm University, Institute for International Economic Studies.
  7. Christopher D. Carroll & Miles S. Kimball, 2001. "Liquidity Constraints and Precautionary Saving," NBER Working Papers 8496, National Bureau of Economic Research, Inc.
  8. Tullio Jappelli & Luigi Pistaferri, 2000. "Intertemporal Choice and Consumption Mobility," Econometric Society World Congress 2000 Contributed Papers 0118, Econometric Society.
  9. Carroll, Christopher D. & Samwick, Andrew A., 1997. "The nature of precautionary wealth," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 41-71, September.
  10. Angus Deaton, 1989. "Saving and Liquidity Constraints," NBER Working Papers 3196, National Bureau of Economic Research, Inc.
  11. 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.
  12. Christopher D. Carroll & Miles S. Kimball, 1995. "On the Concavity of the Consumption Function," Macroeconomics 9503003, EconWPA.
  13. 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.
  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. Richard Blundell & Hamish Low & Ian Preston, 2008. "Decomposing changes in income risk using consumption data," IFS Working Papers W08/13, Institute for Fiscal Studies.
  16. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, December.
  17. Caballero, Ricardo J., 1990. "Consumption puzzles and precautionary savings," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 113-136, January.
  18. Miles S. Kimball, 1990. "Precautionary Saving and the Marginal Propensity to Consume," NBER Working Papers 3403, National Bureau of Economic Research, Inc.
  19. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244, March.
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