PermanentenEinkommens

PermanentenEinkommens, often referred to in economics as permanent income, is the concept that a person’s consumption decisions are driven by a long-run average of expected income rather than by current income alone. It originates from the Permanenten Einkommen Hypothese (PIH) introduced by Milton Friedman in the 1950s. The idea contrasts with models where only current income determines spending, arguing that individuals smooth consumption over time in response to temporary income fluctuations.

Core idea and mechanisms: Households form an assessment of their permanent income, which can be thought of as the present value or the annuity value of expected lifetime resources, including current wealth and anticipated future earnings. When income rises or falls only temporarily, people save or dissave to keep their consumption on a relatively stable path. Permanent income changes, such as a sustained increase in earnings, lead to a more lasting adjustment in consumption.

Determinants and constraints: Permanent income depends on expected future earnings, existing wealth, and prevailing interest rates. The degree to which consumption moves with changes in income depends on factors such as credit access, borrowing constraints, and precautionary saving. In perfectly competitive credit markets with full information, consumption would align closely with changes in permanent income; in reality, frictions soften the response to short-term income shifts.

Applications and critiques: The concept informs analyses of fiscal policy, tax rebates, and unemployment benefits, helping to explain why temporary policy measures may have limited effects on consumption. Critics point to liquidity constraints, uncertainty, and risk as factors that can hinder consumption smoothing, as well as heterogeneity in behavior across households.