Friedman proven wrong regarding accepted permanent income hypothesis
Economists now look to models of short-term thinking by consumers, placing emphasis on fiscal stimulus, writes Noah Smith
When you are wrong, you are wrong, no matter how famous and respected you might be as a scientist. Albert Einstein was wrong about quantum mechanics. Linus Pauling was wrong about the structure of DNA. And Milton Friedman was wrong about the permanent income hypothesis. But unlike the first two examples, where scientists quickly realised the mistake, economists have not yet come to grips with the reality. Friedman’s theory says that people’s consumption is not affected by how much they earn day to day. Instead, what they care about is how much they expect to earn during a lifetime. If they have a sudden, temporary loss of income — a spell of unemployment, for example — they borrow money to ride out the dip. If they get a windfall, such as a government stimulus cheque, they stick it in the bank for a rainy day rather than use it to boost consumption. Only if people believe that their future earning power has changed do they respond by adjusting how much they spend. This idea is impor...
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.
Subscribe now to unlock this article.
Support BusinessLIVE’s award-winning journalism for R129 per month (digital access only).
There’s never been a more important time to support independent journalism in SA. Our subscription packages now offer an ad-free experience for readers.
Cancel anytime.
Questions? Email helpdesk@businesslive.co.za or call 0860 52 52 00. Got a subscription voucher? Redeem it now.