What is the permanent-income hypothesis?
The permanent-income hypothesis, which I have extensively developed, suggests that individuals make consumption decisions based on their expected long-run income, or 'permanent income,' rather than solely on their current income. This implies that temporary changes in income have a relatively small impact on consumption, while changes perceived as permanent have a larger effect. This framework helps explain why consumption tends to be smoother than income and provides insights into how fiscal policy might affect aggregate demand.
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