Stimulus and the Permanent Income Hypothesis
11 Pages Posted: 22 Feb 2021
Date Written: February 19, 2021
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.
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