The Permanent Income Hypothesis Versus Temporary Stimulus Measures

A highlight of my life was visiting with Milton and Rose Friedman in their San Francisco apartment and being served homemade cookies by Rose near Milton’s Nobel Prize hanging on a nearby wall. A few years later I asked Rose to confirm that she really made the cookies herself. She said if she served them, she made them.

Milton Friedman could have earned the highest honor in economics for several of his different contributions individually. My preference would have been for his whole body of work. I’ve always been a bit perplexed that the contribution cited in connection with his prize was his permanent income hypothesis. As Wikipedia summarizes it,

“The Permanent Income Hypothesis states that the choices made by consumers regarding their consumption patterns are determined not by current income, but by longer-term income expectations. The key conclusion of this theory is that transitory, short-term changes in income have little effect on consumer spending behavior.”

There was more to it than that, of course, but it stills sounds rather too obvious to be Nobel Prize material. As with others, however, I’m sure the methodology of reaching the conclusion had more to do with it than the bottom line conclusion itself.

However, that simple bottom line conclusion looms large these days as the administration piles one stimulus on top of another that are expected to produce permanent changes in economic behavior from temporary tax and spending changes, and wonders why they don’t.

Comments (6)

Trackback URL | Comments RSS Feed

  1. Richard (in Arizona) says:

    Isn’t this idea equally applied to the stock market and companies? People often base their investments on the companies future expectations and not current financials.

    I guess the obvious isn’t obvious until someone writes it down. Kind of like some works of “art”.

  2. Benjamin Cole says:

    I am for the least amount of taxes and regs possible, as is anyone else.

    This is blah, blah off the point right now.

    Structural impediments may be better or worse than 20 years ago (and remember, we have 50 states and thousands of local governments with their own impediments), but they certainly have not changed that much for three years ago.

    The National Review magazine has a great article on nominal GDP targeting up online now.

    This is where the conversation belongs, and I encourage Bob McTeer to take a long and serious look at this topic.

    Taxes etc. is like furniture on the deck of the Titanic if we don’t get a fresh and aggressive Fed policy in place.

  3. Mark Glasgow says:

    It makes perfect sense that if a minimum wage worker is provided an annual salary of $100,000 but is told that it will only last two weeks, he will likely change his spending habits little when presented with a limited opportunity to save money. My question, then, is how long must he believe that his new level of income will last before his spending habits conform to his new status quo? I’m curious to know the distinguishing brightline (or a near estimate) for how far into the future consumers need believe that they will maintain their current level of income before they can allow it to affect their current decisions. This entire line of argument seems more deeply steeped in consumer psychology than economic behavior.

  4. John B says:

    Household income took a dip last year. The first annual drop since 1948. That’s from the GDP tables – so not even adjusting for inflation. Consumers just look a their pay stubs and know its time to cut spending. No need to look into the future.

  5. Herbert says:

    I think most people’s spending habits are, to some extent, influenced by their expectations of the future. Only those who lack even the slightest bit of personal planning would spend their money without paying attention to what lies ahead

  6. Nikki says:

    I am personally aleplpad at the portrayal by the media and the treatment by the Democratic Congressmembers of the concerned citizens showing up at all these town hall meetings.Here you have a large number of extremely vocal individuals taking their personal time to attend these meetings and their concerns being dismissed out of hand by the very politicians who invited them to attend and pretended to actually be interested in their opinion when it would have meant good press, but who in reality don’t care at all about the constituents they pretend to represent.I admit that most of these town hall meetings quickly got out of hand and that screaming your views does not get you heard. The meetings quickly deteriorate into a screaming mob.But there is a lesson for everyone there.A screaming mob is a leaderless group by definition. Leaderless The politicians holding the meetings are suppossed to be the leaders, but their immediate loss of control indicates they have also lost the trust of their followers, who feel so abused they must abandon their elected politician to travel their own paths, but are unable to find a voice to rally behind.Rather than learning that lesson or realizing the opportunity this issue presents to pull America together, the politicians all react by criticizing and insulting the public, driving them further away and increasing the divide between parties.The media has jumped on board this effort to divide us all into petty factions by also criticizing the attendees at these meetings, thereby belittling the legitimate concerns of these citizens and abandoning their true job of REPORTING the news in favor of aligning themselves with Obama and editorializing the events of the day.