Consumption responds more to perceived permanent income than to purely transitory income.
Friedman's 1957 hypothesis, and the standard reason for doubting one-off stimulus payments. In practice many households spend substantial fractions of temporary rebates, and the marginal propensity to consume is highest among liquidity-constrained households.
In practice
- A one-off £400 rebate is largely saved; a £30 monthly increase that is expected to persist is spent.
- A contractor with lumpy income spends against the annual average, and a salaried colleague with the same average spends against the month.
- Possible explanations
- The explanation is smoothing: a household that expects a temporary change in income borrows or saves to keep consumption steady, so only lasting changes should move spending much.
- In its favour
- It explains why consumption is far smoother than income, which simple models could not, and it remains the baseline in macroeconomics.
- Against it
- Many households spend substantial fractions of one-off rebates, especially those with little liquid wealth, so the strict version fails where borrowing is constrained.
- Standing
- Many households spend substantial fractions of temporary rebates, especially those holding little liquid wealth.
- Further reading
- Wikipedia
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money