Stimulus and the Permanent Income Hypothesis

Abstract

Government stimulus programs that transfer resources to citizens are meant to spur consumption. I examine the effects of stimulus through the lens of the permanent income (PI) hypothesis. The PI model predicts that a temporary increase in income due to stimulus leads to a small increase in current consumption because recipients save most of the stimulus payment to spread it over consumption for many future periods. This prediction performs well during the end-of-sample pandemic recession of 2020 and the financial crisis recession of 2008-2009, which are the two major recessions of 1959-2020 that lead to substantial temporary stimulus.