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.

Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005
References in periodicals archive ?
While it is generally believed that the permanent income hypothesis does a good job in accounting for the broad features of consumption over time, a number of studies formally reject the theory.
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.
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.
The permanent income hypothesis holds that people's current
If households follow the permanent income hypothesis or the life-cycle model, they rationally assess future retirement needs and adjust saving and consumption appropriately as current asset values change.
The permanent income hypothesis suggests that current income has both permanent and transitory components and that consumer units base their long-term consumption patterns on their permanent income.
Assuming rational forward-looking consumers and perfect capital markets, Hall (1978) demonstrated that under the permanent income hypothesis, consumption should follow a random walk.
The issue of the Permanent Income Hypothesis (PIH) is revisited in this paper by examining the relationship between U.S.
A 2003 Nobel Laureate in economics had this to say on the recent testing of the theory of consumption in terms of the life cycle and permanent income hypothesis as elaborated by Robert Hall: "The theory was like manna from heaven to macro-econometricians.
However, the accumulated empirical evidence regarding actual consumer behavior is not entirely consistent with life cycle theory or the permanent income hypothesis. The young, who according to the theory should exhibit a higher marginal propensity to consume (the fraction of each dollar spent rather than saved) because of the expectation of higher future earnings, consume too little.
For example, one of the classic articles in this area involves Hall's (1978) test of 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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