Working Paper: NBER ID: w8233
Authors: 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.
Keywords: No keywords provided
JEL Codes: D81; D91
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| marginal propensity to consume out of permanent income shocks (mpcp) (E21) | less than 1 (C29) |
| higher levels of permanent income (D15) | lower mpcp (E64) |
| positive shock to permanent income (D15) | decrease in the ratio of assets to permanent income (D14) |
| decrease in the ratio of assets to permanent income (D14) | temporary increase in saving (E21) |
| lower mpcp (E64) | dynamics of saving behavior (D14) |