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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.

Suggested Citation

  • Carroll, Christopher D., 2009. "Precautionary saving and the marginal propensity to consume out of permanent income," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 780-790, September.
  • Handle: RePEc:eee:moneco:v:56:y:2009:i:6:p:780-790
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    References listed on IDEAS

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    More about this item

    Keywords

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

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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