The relative income hypothesis

Abstract

Despite its theoretical dominance, the empirical case in favor of the permanent income hypothesis is at best a weak one. Contrary to one of its basic implications, a growing body of evidence suggests that rich households save a higher proportion of their permanent income than poor households. Following Duesenberry (1949), we propose an overlapping generations economy where households care about relative consumption, the di¤erence between their consumption and the consumption of their reference group. As a result, an individual's consumption is driven by the comparison of his lifetime income and the lifetime income of his reference group; a permanent income version of the Duesenberry's (1949) relative income hypothesis. Across households the savings rate increases with income while aggregate savings are independent of the income distribution. Positional concerns lead agents to over-consume, over-work, and under-save, relative to the welfare maximizing levels that a planner would choose. We propose a simple tax schedule that induces the competitive economy to achieve allocative e¢ ciency. JEL Classi…cation: D62, E21, H21

Empirical Investigation of the Determinants of Tanzania’s National Savings

“…The RIH assumes that the percent of income saved will be independent of the absolute level of income. Hence, the aggregate saving ratio will be independent of the absolute level of income (Alimi, 2013, Alvarez-Cuadrado andLong, 2011). This implies that the MPS of an individual would be higher if his percentile position in the income distribution is higher.…”

Study on the Consumption Level of Rural Residents in China

“…On the other hand, in the relative income hypothesis proposed by James Stemble Duesenberry, consumption is up to income distribution and the highest income level of consumers in the history. Duesenberry put forward that consumption does not depend on current absolute income level but on relative income level, including two aspects: one is the income level relative to other people's income level, referring to that consumers' consumption behavior will be affected by each other, generally called "demonstration effect" or "bandwagon effect"; the other is the income level relative to consumers' own historical consumption level, referring to that because of consumers' consumption habit, their consumption will not necessarily reduce immediately when their income reduces , generally called "habit effect" [6]. Therefore, considering a decisive role the income plays in consumers' consumption level, in this paper, per capita disposable income of rural residents was used as one of explanatory variables, represented by X2.…”

Income Shares, Secular Stagnation, and the Long-Run Distribution of Wealth

“…Empirical evidence using Consumer Expenditure Survey data from the United States suggests that consumption peer effects are large-over 30% in magnitude-for the bottom quintiles of the income distribution, but vanish as top income earners are considered (Petach and Tavani, 2018). Thus, we assume that, while capitalists derive (logarithmic, for simplicity) utility from their own consumption c c , workers have (logarithmic, again) preferences that reflect so-called "external habits", or their intent to "keep up with the Joneses" (Ljunqvist and Uhlig, 2000; Turnovsky et al, 2004;Dynan and Ravina, 2007;Alvarez-Cuadrado and Van Long, 2011):…”