Table of Contents
- What Is the Permanent Income Hypothesis?
- Understanding the Permanent Income Hypothesis
- Spending Habits Under the Permanent Income Hypothesis
- Liquidity and the Permanent Income Hypothesis
- What Is the Difference Between Life Cycle Income Hypothesis and Permanent Income Hypothesis?
- What Is the Difference Between Permanent Income and Transitory Income?
- How Much Does the Average American Spend on Non-essentials?
- The Bottom Line
What Is the Permanent Income Hypothesis?
Let me explain the permanent income hypothesis directly: it's an economic theory where you base your spending on what you expect to earn over the long haul, not just your paycheck right now. Your permanent income is that steady average you anticipate for life, and that's what you spend against. If you get a one-time bonus, don't expect to splurge wildly because it's temporary—you're more likely to save it. When your current income tops your expected permanent level, you save the difference, and you borrow when it's the other way around.
Key Takeaways
- You spend based on expected income, not current earnings.
- Temporary income shifts won't change your spending patterns much.
- You save when earning more now but borrow expecting more later.
Understanding the Permanent Income Hypothesis
This theory comes from Milton Friedman, the Nobel winner, back in 1957. It means consumption changes are hard to predict since they're tied to personal expectations, and that affects economic policy big time. Even if a policy boosts income, it might not spark more spending right away—no multiplier effect—until people update their future income views.
Friedman argued you consume based on future income estimates, unlike Keynes who said it's about after-tax income now. The idea is you smooth out your spending to avoid ups and downs from short-term income swings.
Spending Habits Under the Permanent Income Hypothesis
Say you're expecting a bonus at the end of the pay period—you might adjust spending ahead, but you could also just save it, knowing it's not permanent. The same goes for an inheritance: you might keep spending steady and save or invest the extra for long-term growth, rather than blowing it on stuff right away.
Liquidity and the Permanent Income Hypothesis
Your liquidity matters here—if you have no assets, you might spend regardless of income, current or future. But over time, things like steady raises or a better job can lift your permanent income expectations, letting you scale up spending accordingly.
What Is the Difference Between Life Cycle Income Hypothesis and Permanent Income Hypothesis?
The life cycle hypothesis looks at how your saving and spending evolve over your lifetime as you age. In contrast, the permanent income hypothesis is about spending tied to expected income at any life stage.
What Is the Difference Between Permanent Income and Transitory Income?
Transitory income is those temporary, unexpected bumps from unreliable sources. Permanent income is your stable, expected average over the long term.
How Much Does the Average American Spend on Non-essentials?
From a OnePoll survey, the average American drops about $1,497 monthly on non-essentials, adding up to nearly $18,000 yearly.
The Bottom Line
To wrap this up, Friedman's permanent income hypothesis says you spend based on long-term expected average income, so policies to pump up spending might not work immediately if expectations don't shift.
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