Do Consumers Behave as the Life-Cycle/Permanent-Income Theory of Consumption Predicts?
Widely accepted theories of consumer behavior suggest that consumers act according to a lifetime budget, spending against future earnings so long as they are predictable. Yet this study finds that many consumers respond to changes in income only when they are realized. Furthermore, adjustment costs lead to deviations in the short run from the Life-Cycle/Permanent-Income path.
These findings suggest that some temporary economic policies may have a larger impact on consumption than LC/PI theory predicts, since consumers do not or cannot spread out the effects over their lifetime. Conversely, permanent policies may have more sluggish results than the theories predict, as consumers require time to adjust consumption to the new level of lifetime resources.