曼昆第10版讲义mankiw10e-irm-ch19

CHAPTER19 TheMicrofoundationsofConsumptionandInvestment

LectureNotes

CHAPTER19

TheMicrofoundationsofConsumptionandInvestment

NotestotheInstructor

ChapterSummary

Thischapterdiscussesindetailtheoriesunderpinningourunderstandingaboutconsumptionandinvestment.Itisstructuredtofollow,moreorless,thehistoryofthoughtonthesetopics.

Forconsumption,thechapterbeginswiththeKeynesianconsumptionfunction,thendiscussesIrvingFisher’smodelofintertemporalchoice,andthenaddressesthelife-cycleandpermanent-incometheoriesofconsumption.Thechapteralsoincludesadiscussionofrational-expectationstheoriesofconsumption.Forinvestment,thechapterprovidesadiscussionoftheneoclassicalmodelofinvestmentandthenconsiderstheroleofthestockmarketandTobin’sqasanalternative(butsimilar)wayofconsideringfirms’investmentdecisions.

Comments

Thismaterialprobablyrequirestwotothreelectures.Thisisagoodtimetodiscusstheimportanceofmicrofoundationsinmacroeconomicmodels.Isuggesttostudentsthatthematerialinthischapterallowsustobothjustifyandtorefinetheimportantbehavioralassumptionsthatunderlietheearliermodels.Indoingso,weimprovetheperformanceoftheshort-runmacroeconomicmodel.

Thischaptercanbetreatedasanextendedcasestudyonthedevelopmentoftheoriesineconomics;itprovidesagoodillustrationoftheproductiveinterplayoftheoryanddata.Forthesectiononconsumption,theprimarymotivationisthepuzzleofthedifferencebetweentheshort-run(cross-section)andlong-run(timeseries)consumptionfunction.Thebiggestdifficultyinpresentingthismaterialisthatthetheoryofintertemporalchoicetakessometimetodevelop;bythetimeitiscomplete,studentsmayhaveforgottenthemotivation.Itisworthgoingbackandremindingstudentsofthepuzzleatthatpoint.Forthesectiononinvestment,themainmotivationistoexplaintheevidenceshowinghowinvestmentrespondstheinterestratethroughitseffectonthecostofcapital.ThediscussionofTobin’sqalsoprovidesanopportunitytodiscusstheroleofthestockmarketasanindicatorofeconomicactivity.

Studentsalsoseemtodislikethe“unrealistic”assumptionsofthelife-cyclemodel—inparticular,thefactthat,inasimpletextbooktreatment,weassumethatpeopleknowtheirlifetimeincomeandtimeofdeathwithcertainty(andweoftenassumeazerointerestrate).Itry,first,toreassurestudentsthatwedoknowhowtorelaxtheseassumptionsand,second,topointoutthatwehaveatleastimproveduponthenaiveKeynesianconsumptionfunction,whichisevenmoreunrealistic.Itrytoleavethestudentswiththelessonthat,inthinkingaboutchangesinincome,twodistinctionsmatter:temporaryversuspermanentandanticipatedversusunanticipated.Studentsfinditsurprisingthatthecorporatetax,absentanyinflationdistortions,willnotalterinvestmentdecisions,countertowhattheyhearfrompoliticiansorcommentators.Ifindthisisagoodplacetoemphasizethatwhatmattersisincentivesatthemargin.

UseoftheWebsite

Oneimportantadvantageoftheweb-basedsoftwareisthatitallowsstudentstoseeexplicitlife-cyclebehaviorwithanonzerointerestrateandalsotoseehowmuchdifferenceinterestratechangescanmake.Studentsmayalsobesurprisedathowdifficultitistosmooththeirconsumptionovertheirlifetime.Studentscouldalsotrytoobtainsomethingotherthanacompletelysmoothconsumptionpath—onepossibilitywouldbeconsumptionincreasinggraduallythroughthelifetime;anotherwouldbesmoothconsumptionexceptforablipsomewhereinmiddleage(say,forfinancingchildrenthroughcollege).

UseoftheEWebsite

GototheEwebsiteanddownloadquarterlydataonthemajorcomponentsofpersonalconsumptionexpenditures(durable,nondurable,andservices)intheUnitedStatesoverthepast10years.Assesstheeffectoftherecessionof2001andtherecessionof2008–2009onconsumerspending.Didconsumerspendingdeclineduringtheserecessions?Didcertaincomponentsdeclinebutnotothers?The2008–2009recessionwasaccompaniedbyasubstantialdeclineinrealhouseholdwealth.Whatcomponentsofconsumptionwouldyouexpectthistomostaffect?Dothedataconfirmyourexpectation?NowgototheEwebsiteanddownloadquarterlydataonthemajorcomponentsofinvestmentexpenditures(businessfixed,residential,andinventory)intheUnitedStatesoverthepast10years.Assesstheeffectoftherecessionof2001andtherecessionof2008–2009oninvestmentspending.Didinvestmentspendingdeclineduringtheserecessions?Didcertaincomponentsdeclinebutnotothers?The2008–2009recessionwasaccompaniedbyasubstantialdeclineinthestockmarketandaseverecontractionintheavailabilityofcredit.Whatcomponentsofinvestmentwouldyouexpectthistomostaffect?Dothedataconfirmyourexpectation?

ChapterSupplements

19-1 TheComponentsofConsumption

19-2 TheStockMarketandConsumerSpending

19-3 SavingandtheFearofNuclearWar

19-4 The1975TaxCut(CaseStudy)

19-5 DoConsumersAnticipateChangesinSocialSecurityBenefits?(CaseStudy)

19-6 IsUnemploymentInsuranceReallyanAutomaticStabilizer?

19-7 TheShortRunandtheLongRun:InvestmentandtheCapitalStock

19-8 TaxInversionsandCorporateTaxReform

19-9 FinancingConstraintsinJapaneseFirms

19-10 Taxes,Babies,andHousing

19-11 TheTaxTreatmentofHousing

19-12 TheImportanceofInventories

19-13 InventoriesandProductionSmoothing

19-14 ProductionSmoothingandCoordinationFailure

19-15 TheMultiplier-AcceleratorModel

19-16 AdditionalReadings

LectureNotes

Introduction

Modernmacroeconomicsemphasizestheneedforsolidmicroeconomicfoundations.Althoughwemakemanysimplificationsinmacroeconomicsandignoremostdifferencesamongindividuals,westillhopethatourmacroeconomictheoryisgroundedinsensiblemicroeconomics.Macroeconomicsandmicroeconomics,afterall,shouldnotbecompletelyseparatedisciplines;theyareattemptstounderstandeconomicphenomenaondifferentscales.

Thischapterofthetextbookconsidersthemicrofoundationsofconsumptionandinvestment.Theseareimportantingredientsofourmodeloftheeconomy,andsoweneedagoodunderstandingofthem.Amoredetailedconsiderationoftheseelementsofourmodelsisolatesthestrengthsandweaknessesofcurrenttheoryandallowsustorefineandimproveourunderstandingoftheeconomy.

19-1 WhatDeterminesConsumerSpending?

Supplement19-1,“TheComponentsofConsumption”

Westartwithconsumptiontheory,sinceitissocentraltoourearlieranalyses.Theconsumption–savingdecisionisthekeybehavioralelementoftheSolowgrowthmodelandalsounderliesthemultipliereffectsintheshort-runmodel.Consumptionisalsothebiggestcomponentofaggregatedemand,accountingforabouttwo-thirdsofGDP.Wecannothaveagoodunderstandingoftheeconomyunlesswehaveagoodtheoryofconsumption.

JohnMaynardKeynesandtheConsumptionFunction

JohnMaynardKeynesinTheGeneralTheoryofEmployment,InterestandMoneyintroducedtheconsumptionfunctionintomacroeconomics.WestartouranalysisbyconsideringKeynes’sideasabouttheconsumptionfunction.

Keynes’sConjecturesRecallthatourmodelsarebasedonasimpleconsumptionfunction:

C=C(Y–T).

Forexample,theconsumptionfunctionmightbe

Figure19-1

ThissimpleKeynesianconsumptionfunctionisnotabadstartingpoint.Itcapturesanumberofplausiblenotionsaboutpeople’sbehavior:thattheywillalwayswanttoconsumesomething;thattheywillconsumemoreastheirincomegoesup;andthattheywilltendtospendsomeandsavesomeofeachadditionaldollarofdisposableincomethattheyearn.Wecansummarizethesefeaturesasfollows:

Themarginalpropensitytoconsume(c)isbetweenzeroandone.

Theaveragepropensitytoconsume(C/Y)isadecreasingfunctionofincome.

Keynesconjecturedthatthesefeatureswerecharacteristicsofactualconsumptionbehavior.

Thisconsumptionfunctionisalsoabitnaive.First,theconsumptiondecisionis,equivalently,asavingdecision.Therefore,consumptiontheoryshouldbeaboutthechoicebetweenconsumingnowandconsumingatsomepointinthefuture.ThatintertemporalaspectissuppressedintheKeynesianconsumptionfunctionasevidenced,forexample,bythefactthatitomitstheinterestrateentirely.Itiscertainlytoosimpletosupposethatpeoplelookonlyattheircurrentincomewhentheyaremakingtheirconsumption–savingdecision.Thistheoreticalsubtletywasrecognizedbyeconomistsandwasalsoreflectedinempiricalpuzzlesthatemergedwheneconomistsbegantolookatthedata.

TheEarlyEmpiricalSuccessesEarlyworkseemedtosupporttheKeynesianconsumptionfunction.Surveysofhouseholdsfoundthathouseholdswithhigherincomesbothconsumedmoreandsavedahigherproportionoftheirincome,supportingKeynes’sconjectures.Also,aggregatedataapparentlyconfirmedthatbothconsumptionandsavingwerelowwhenincomewaslow.

TheConsumptionPuzzleAsmoredatabecameavailableandmorestudieswereconducted,theevidencebecamelessclear.First,theKeynesianconsumptionfunctionimpliesthatsavingincreasesasincomeincreases.Someeconomists,therefore,fearedthattherewouldeventuallynotbeenoughinvestmentprojectsavailabletoabsorbthissaving,leadingtoinadequatedemandandsecularstagnation(thatis,anindefinitedepression).ItwasfearedinparticularthatthismightcomeaboutaftertheendofWorldWarII.Infact,theriseinincomeafterWorldWarIIwasnotaccompaniedbyhigheraveragesaving.Thatis,theaveragepropensitytoconsumedidnotfallasincomerose.ThisfindingwasconfirmedinastudybySimonKuznets,whodiscoveredthattheaveragepropensitytoconsumewasstableoverlongperiodsoftime.

Thus,researchersseemedtofindadifferencebetweenshort-runandlong-runbehavior.Whentheytookasampleofpeopleatsomepointintime,theyfoundthattheKeynesianconsumptionfunctionworkedwell.Butoveralongerperiodoftime,whenincomesweregrowing,theKeynesianfunctiondidnotdosowell.Instead,consumptionwasapproximatelyproportionaltoincome.Onewaytosummarizethesefindingsisthatthelong-runmarginalpropensitytoconsumedifferedfromtheshort-runmarginalpropensitytoconsume.Anotherwayofputtingthisisthatthelong-runconsumptionfunctionwassteeperthantheshort-runconsumptionfunction.

Figure19-2

Reconcilingthesetwoconsumptionfunctionswasamajorchallengetoeconomistsinthe1950s.Twotheoriesweredeveloped:thelife-cyclemodelandthepermanent-incomemodel.Atthetime,thesewereseenascompetingmodels,butmoderneconomicsviewsthemasessentiallycomplementary,makingthesameessentialpointbutwithdifferentemphases.Insteadofthinkingthatpeoplelookonlyatthisyear’sincomewhentheymaketheirconsumptiondecisions,thesetheoriesrecognizethatpeoplealsothinkaboutwhattheirincomeislikelytobeinthefuture.Peoplemakeplansforthefuture,andtheirconsumptiondecisionsreflectthoseplans.

AmoresophisticatedviewthanthesimpleKeynesianconsumptionfunction,therefore,viewstoday’sconsumptionaspartofaplanthatextendsintothefuture.Thisplanisnotimmutable:astimegoesby,peoplerevisetheirconsumptionplans,perhapsbecausetheygetnewinformation,orperhapssimplybecausetheychangetheirmindsaboutwhattheywanttodo.Nonetheless,mostpeople’sconsumptiondecisionsprobablyincorporateaforward-lookingelement.

Wehavenowcreatedamorecomplicatedproblem,butwecanstillgetagoodunderstandingbymakingappropriatesimplifications.Beforeweconsiderthelife-cycleandpermanent-incometheoriesindetail,weanalyzeasimplertwo-periodchoiceproblem—theFishermodel.

FrancoModiglianiandtheLife-CycleHypothesis

Wenowreturntotheattemptstoexplaintheconflictingresultsonconsumption,thatis,theideathatthelong-runconsumptionfunctionissteeperthantheshort-runconsumptionfunction.FrancoModigliani,AlbertAndo,andRichardBrumbergproposedanexplanationbasedontheideasintheFishermodel.Inparticular,theyfocusedontheroleofsavinginsmoothingindividuals’consumptionovertheirlifetimes.

TheHypothesisAstylizedfactofeconomicdataisthatconsumptionismuchsmootherthanincome.Thissuggeststhatpeoplemayusesavingtoshiftresourcesfromtimesofhighincometotimesoflowincometomaintainarelativelyconstantlevelofconsumption.Thelife-cyclehypothesisisbasedontheideathatpeoplewishtosmooththeirconsumptionovertheirlifetime.Inparticular,therefore,theysaveduringtheirworkingyearstofinanceconsumptionduringtheirretirement.

Althoughpeoplecanborrowatsomepointsoftheirlivesandsaveatotherpoints,theystillhavetobalancetheseoutoveralongerperiod.Thatis,individualsfaceanintertemporalbudgetconstraint,justasintheFishermodel.Atanypointintime,thepresentvalueofconsumptionmustequalthepresentvalueoflifetimeincomeplusanyinitialwealth.LetusconsiderthisbudgetconstraintforsomeonewhoexpectstoliveforTmoreyears,ofwhichRwillbespentworkingandtheremainingT–Rwillbespentinretirementwithzeroearnings.WeassumethatinitialwealthequalsWandthattherealinterestrateiszero.Thentheintertemporalbudgetconstraintis

C1+C2+...+CT=W+Y1+Y2+...+YR.

NowsupposethatearningsequalYineveryworkingyearandthattheindividualwishestosmoothhisconsumptionperfectly,sothatheconsumesCineveryyear.Thenthebudgetconstraintimpliesthat

CT=W+RY.

Consumptionisgivenby

C=(1/T)W+(R/T)Y.

Consumptiondependsuponincomeandwealth.Ifweaggregateovertheentireeconomy,weget

C=αW+βY,

whereαisthemarginalpropensitytoconsumeoutofwealthandβisthemarginalpropensitytoconsumeoutofincome.Thekeypointisthatαislikelytobeasmallnumber,whereasβismuchlarger.

ImplicationsTheconsumptionfunctionjustderivedresemblesthesimpleKeynesianconsumptionfunction,exceptthattheinterceptterm(αW)isnowafunctionofwealth.Aswealthincreases,peoplewillconsumemoreatalllevelsofincome.TheotherdifferenceisthatYisnotnecessarilycurrentincomebutismorelikeanaverageofcurrentandfutureincome.Ifcurrentandfutureincomealwayschangetogether,thenthisdistinctiondoesnotmatter.Weleaveitasideforthepresentandreturntothetopicwhenweconsiderthepermanent-incomehypothesis.

Figure19-3

Figure19-4

Supplement19-2,“TheStockMarketandConsumerSpending”

Thelife-cyclemodelreconcilestheshort-runandlong-runconsumptionfunctions.Intheshortrun,wealthisapproximatelyconstant,soweobtainaKeynesianconsumptionfunction.Butinthelongrun,wealthincreaseswithincome,sotheaveragepropensitytoconsumeisconstant:

APC=C/Y=α(W/Y)+β.

Wecanalsolookatanindividual’slifetimepatternofconsumption,income,andwealth.Hiswealthgrowsduringhisworkingyears,whenheissaving,andfallsduringhisretirementyears,whenheisdissaving.Thelife-cyclemodelisverystylized,butitmakesimportantpointsveryclearly.Wecan,inprinciple,amendthemodelinmanywaystomakeitmorerealistic.Forexample,wecanaddinpositiveinterestrates,morecomplicatedconsumptionpatterns,uncertaintyaboutfutureincomeandabouttimeofdeath,andsoon.Alltheseamendmentsmakethemodelmorecomplicated,butthebasicmessageisthesame;westillendupwithapicturethatresemblesFigure19-3inthetextbook.

Figure19-5

Supplement19-3,“SavingandtheFearofNuclearWar”

Thelife-cyclemodelpredictsthattheelderlydissave;however,empiricalresearchsuggeststhattheelderlydonotdissaveattheratethelife-cyclemodelsuggests.Onepossibleexplanationistheiruncertaintyaboutthefuture.Theelderlydonotknowexactlyhowlongtheyaregoingtoliveandalsomayfacethepossibilityoflargemedicalbills.Theymayengageinprecautionarysaving.Theymayalsoplantoleavebequests(asdiscussedinChapter19).

MiltonFriedmanandthePermanent-IncomeHypothesis

MiltonFriedman’sapproachtoconsumptiontheorycomplementsthelife-cyclemodel.Unlikethatmodel,however,Friedman’spermanent-incomehypothesisfocusesontheeffectsonconsumptionofrandomandunpredictablechangesinincome.

TheHypothesisFriedmansuggesteddecomposingtotalincomeintoapermanentorpredictablecomponentandatemporaryorrandomcomponent:

Y=YP+YT.

Hisideawasthattransitoryincome(YT)doesnothavealargeeffectonconsumption.Forexample,ifanindividualobtainsa$1,000bonusfromhisemployer,becausehiscompanyhadagoodyear,heislikelytosavemostofittokeephisconsumptionsmooth.Bycontrast,ifhereceivesa$1,000raise,hispermanentincome(YP)ishigherandheislikelytoincreasehisconsumptionperyearbycloseto$1,000.Friedmanthusarguedthatwecanviewconsumptionasapproximatelyproportionaltopermanentincome:

C=αYP.

Thisissimilartothelife-cyclehypothesisifweviewtransitoryincomeaschangesinwealthandpermanentincomeaschangesinincome.Themarginalpropensitytoconsumeoutoftransitoryincome(wealth)islow;themarginalpropensitytoconsumeoutof(permanent)incomeishigh.

ImplicationsWecanwriteYP=Y–YT.Wethusobtainthattheaveragepropensitytoconsumeis

APC=αYP/Y=α(1–YT/Y).

Whentransitoryincomeispositive,APCwillbelowerandviceversa.High-incomehouseholds,onaverage,arethosewithpositivetransitoryincomeandsoexhibit,onaverage,alowaveragepropensitytoconsume.Overtime,however,incomechangesbecauseofchangesinpermanentincome.

Tounderstandtheeffectsofchangesinincomeonconsumption,wethereforeneedtoknowwhetherachangeinincomeistemporaryorpermanent,sincea$1,000temporaryincreaseinincomeleadstoasmallincreaseinconsumption,whereasa$1,000permanentincreaseinincomeleadstoalargeincreaseinconsumption.Whatwesee,aseconomiststryingtounderstandthedata,isa$1,000increaseinincomeineithercase.AneconomistarmedwithasimpleKeynesianconsumptionfunctionwouldpredictthesameresponseofconsumption.

CaseStudy:The1964TaxCutandthe1968TaxSurcharge

Thetemporary/permanentdistinctionisveryimportantforcorrectpolicyanalysis.In1964therewasareductioninincometaxesthatwasannouncedtobepermanent.Individualsthusrevisedtheirestimatesoftheirpermanentincomeupwardandincreasedtheirconsumption.Thishadtheeffectofstimulatingtheeconomy.In1968,bycontrast,therewasatemporarytaxsurcharge.Theideawastotrytocontractaggregatedemand,whichhadbeengreatlyincreasedbytheVietnamWar.Asthepermanent-incomehypothesissuggests,thismeasurewasunsuccessful.Consumers,recognizingthatthetaxsurchargewastemporary,simplydrewdowntheirsavingandadjustedtheirconsumptionverylittle.Althoughthisevidenceisconsistentwiththepermanentincometheory,wecannotdefinitivelyconcludethattemporarytaxchangeshavelittleornoeffect.Otherfactors—suchasconsumerconfidence—influencespending,soitisdifficulttoseparatetheeffectsoftaxpolicyfromothereventsoccurringsimultaneously.

Supplement19-4,“The1975TaxCut”

CaseStudy:TheTaxRebatesof2008

Inresponsetoanimminentrecession,Congressearlyin2008passedtheEconomicStimulusAct,providingone-timetaxrebatestohouseholds.Becausesendingoutmillionsofcheckstakestime,householdsreceivedtheirpaymentsatdifferenttimesbetweenMayandJulyofthatyear.Thetimingofthepaymentswasbasedonthelasttwodigitsofthetaxpayer’sSocialSecuritynumber,whichisrandom.Asaresult,thetaxrebatesprovideanexperimentthatcanbeusedtotestthepermanent-incomehypothesis.Ifthepermanentincomehypothesisiscorrect,thetaxrebatesshouldhavebeenviewedastransitoryincreasesinincomeandthusshouldhavehadlittleornoeffectonpermanentincomeorconsumptionspending.And,inparticular,thosereceivinglatepaymentsshouldhavebehavedthesameasthosereceivingearlypayments.Arecentstudyfoundinsteadthatthetimingoftherebatehadalargeeffectonthetimingofahousehold’sspending,withthosereceivingthecheckearlierincreasingspendingearlierthanthosewhoreceivedthechecklater.Overall,thestudyfoundthataveragehouseholdspendingincreasedbyabout50percentto90percentofthepayment.Theseresultssuggestthatevenifthepermanent-incometheoryiscorrectinpredictinglargereffectsonconsumerspendingfrompermanenttaxchangesthanfromtransitorychanges,thelatterstillhavesignificanteffectsonspending.

RobertHallandtheRandom-WalkHypothesis

Recentworkonconsumptionhascombinedrationalexpectationswiththepermanent-incomehypothesis,whichreallymeansassumingthatpeopleareverysophisticatedintheirguessesaboutwhattheirincomeisgoingtodo.

TheHypothesisRobertHallwasthefirsteconomisttoshowhowrationalexpectationsinfluencethepatternofconsumptionovertime.Ifconsumershaverationalexpectationsandfollowthepermanent-incomehypothesis,thenconsumptionfollowsarandomwalk.Thismeansthatthebestpredictionofconsumptionduringthisperiodisthatitwillbethesameasitwasintherecentpast.Inotherwords,changesinconsumptionareunpredictable.Whyisthis?Ifpeoplehaverationalexpectations,thentheyarecontinuallytakingaccountofeverypieceofinformationthatcomestheirwaytosmooththeirconsumptionasbesttheycan.Theywillchangetheirconsumptiononlyifthereisanunpredictablechangeintheirincome.Suchchangesoccurallthetime—butifindividualscannotpredictthem,thenneithercaneconomists,sinceeconomistsarenosmarterandhavenomoreinformationthanconsumersdo.ThistheoryhasbeentestedbyHallandothers.Itturnsoutthatconsumptionrespondstopastincomeandsoissomewhatpredictable,incontrasttowhatthetheoryproposes.

ImplicationsAnimplicationofthisideaisthatifwearetryingtoexplainconsumptionbehavior,weneedtoknownotonlyifchangesinincomearetemporaryorpermanentbutalsoiftheyareanticipatedorunanticipated.Ifaconsumeristoldthisyearthathewillreceivearaisenextyear,thentherational-expectationsviewofconsumptionpredictsthathisconsumptionwillincreasethisyear,eventhoughherincomehasnotchanged.Nextyear,bycontrast,hewillnotalterhisconsumptionatallwhentheincomechangeactuallyoccurs.Accordingtothistheory,consumptionrespondstochangesininformationaboutincome.SuchbehaviorisnotexplicableintermsofasimpleKeynesianconsumptionfunction.

CaseStudy:DoPredictableChangesinIncomeLeadtoPredictableChangesinConsumption?

Ifchangesinincomearepredictable,thenaccordingtotherandom-walktheory,weshouldobservenochangeinconsumptionwhenincomechanges.Individualsshouldadjusttheirconsumptionassoonastheyknowthattheirincomewillchangeratherthanwaitforthechangetooccur.

Supplement19-5,“DoConsumersAnticipateChangesinSocialSecurityBenefits?”

Supplement19-6,“IsUnemploymentInsuranceReallyanAutomaticStabilizer?”

Theobservationthatincomeandconsumptionfluctuatetogetheroverthebusinesscycledoesnotnegatetherandom-walktheorybecausemanychangesinincomeareunpredictable.Studiesofpredictableincomechangesshowthatwhenincomeisexpectedtochange,consumptionchangesaswellbutbyhalfasmuchastheexpectedchangeinincome.Thisdifferencemaybeexplainedbyalackofrationalexpectationsonthepartofconsumersorborrowingconstraints.Inanycase,currentincomehasalargerroleindeterminingconsumptionthantherandom-walktheorysuggests.

DavidLaibsonandthePullofInstantGratification

Economistsinrecentyearshaveturnedtopsychologyforexplanationsofconsumerbehavior.OneofthemoreprominenteconomistsbringinginsightsfrompsychologyintothestudyofconsumptionisDavidLaibson.Hefindsthatmanyconsumersbelievethemselvestobepoordecisionmakers.Forexample,manyrespondentstosurveysunderstandperfectlywellthattheyaresavingtoolittleforretirement,yettheydon’tsummonthewilltochangetheirbehavior.Partofthereasoncouldbethatconsumers’preferencesmaybetime-inconsistent,inthesensethatconsumersaltertheirdecisionssimplybecausetimehaspassed.Workisproceedingonthispromisingareaofresearchfromwhichwemaygainnewinsightsregardingtheeffectsofeconomicpoliciesonconsumerbehavior.

CaseStudy:HowtoGetPeopletoSaveMore

Thefieldofbehavioraleconomicsofferssomesuggestionsforgettingpeopletosavemore.Oneapproachistotakeadvantageofinertiainpeople’sdecisionmaking—forexample,byautomaticallyenrollingemployeesinacompany’s401(k)retirementplanratherthanrequiringemployeestosignupfortheplaninadvance.Studieshaveshownthatpeoplearefarlesslikelytoactivelyoptoutoncetheyareenrolledina401(k)plan,justastheyarefarlesslikelytoactivelyoptiniftheyarenotenrolled.Asecondapproachtoincreasingsavingistoprovideawayforpeopletocontroltheirdesireforinstantgratification.Forexample,programsthatofferworkerstheoptionofautomaticallysavingaportionofanyfutureraiseinsalaryhaveshownpromisingresultsforincreasingsaving.

TheBottomLineonConsumption

Thepermanent-incomeandlife-cyclehypothesesbreakthestrong,simplelinkbetweendisposableincomeandconsumptionthattheKeynesianconsumptionfunctionposits.ThislinkunderliesthemultiplierintheIS–LMmodel.Thesemoresophisticatedtheoriesofconsumptionthuscastsomedoubtonacentralelementofourshort-runmodel.Oneimplicationisthatwemustbewaryaboutourabilitytouseaggregatedemandmanagementtostabilizetheeconomy,asthefailedtaxsurchargeof1968demonstrates.

Nevertheless,wedonotneedtoabandonourshort-runmodel.AlthoughmoremoderntheoriesofconsumptionareevidentlysuperiortothesimpleKeynesianconsumptionfunction,thereisstillevidencethatconsumptiondoesrespondtocurrentincome,astheKeynesianconsumptionfunctionsuggests.Onepossiblereas