permanent income hypothesis


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permanent income hypothesis

the hypothesis that states that current CONSUMPTION is not dependent solely on current DISPOSABLE INCOME but also on whether or not that income is expected to be permanent or transitory. The permanent income hypothesis argues that both income and consumption are split into two parts, permanent and transitory. A person's permanent income comprises such things as their long-term earnings from employment (WAGES, SALARIES), retirement pensions and income derived from the possession of capital assets (INTEREST, DIVIDENDS). The amount of a person's permanent income will determine permanent consumption plans, for example, the size and quality of the house he or she will buy and thus long-term expenditure on mortgage repayments, etc.

Transitory income comprises short-term temporary overtime payments, bonuses and ‘windfall’ gains from winnings and inheritances, and short-term reductions in income arising from temporary unemployment and illness. Transitory consumption such as additional holidays, clothes, etc., will depend upon the amount of this extra income.

Long-term consumption may also be related to changes in a person's WEALTH, in particular the value of his or her house over time.

The economic significance of the permanent-income hypothesis is that in the short term the level of consumption may be higher (or lower) than that indicated by the level of current disposable income. See LIFE-CYCLE HYPOTHESIS, KEYNESIAN ECONOMICS, CONSUMPTION FUNCTION.

References in periodicals archive ?
Permanent Income Hypothesis, Myopia and Liquidity Constraints: A Case Study of Pakistan.
The main difference between CRRA preferences and quadratic preferences is that the permanent income hypothesis does not hold under CRRA preferences.
4) Campbell and Mankiw (1991) separate the consumption behaviour of households into two parts as those individuals who follow the permanent income hypothesis and those who simply consume their current income.
The Permanent Income Hypothesis (Friedman 1957) and Life-cycle Theory (Modigliani 1970) suggest that consumers will keep a constant level of consumption over the course of their lifetime, provided that they can accurately forecast their permanent income or wealth over the course of their lifespan.
A second empirical failing of the permanent income hypothesis is
5) Ireland provides an excellent discussion of Friedman's permanent income hypothesis.
Empirical studies typically find that private consumption is much more sensitive to current disposable income than is predicted by Hall's (1978) permanent income hypothesis.
The most influential and perhaps most widely tested view of this relationship is the Permanent Income Hypothesis (PIH) [Hall, 1978, 1989].
While he recognized Friedman's permanent income hypothesis under the umbrella of "important further developments" (Modigliani 2002, 15), he makes the significant distinction that "Friedman assumes an infinite time horizon for consumption and saving decisions whereas my hypothesis depends on life being finite and differentiated--dependency, maturity, and retirement" (Breit and Spencer 1995, 151).
However, the accumulated empirical evidence regarding actual consumer behavior is not entirely consistent with life cycle theory or the permanent income hypothesis.
Roughly speaking, the permanent income hypothesis states that consumption should be a function of permanent income (or, when discounted, permanent wealth) and should not depend on transitory income measures.

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