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...

BL Premium

This article is reserved for our subscribers.

A subscription helps you enjoy the best of our business content every day along with benefits such as exclusive Financial Times articles, Morningstar financial data, and digital access to the Sunday Times and Times Select.

Already subscribed? Simply sign in below.



Questions or problems? Email helpdesk@businesslive.co.za or call 0860 52 52 00.