Precautionary Saving and the Marginal Propensity to Consume Out of Permanent Income

21 Pages Posted: 12 Aug 2009 Last revised: 21 Oct 2010

See all articles by Christopher D. Carroll

Christopher D. Carroll

Johns Hopkins University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: April 2001

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.

Suggested Citation

Carroll, Christopher D., Precautionary Saving and the Marginal Propensity to Consume Out of Permanent Income (April 2001). NBER Working Paper No. w8233, Available at SSRN: https://ssrn.com/abstract=1447666

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