The Relative Permanent Income Theory of Consumption: A Synthetic Keynes-Duesenberry-Friedman Model

This paper presents a theory of consumption that synthesizes the seminal contributions of Keynes (1936), Duesenberry (1948), and Friedman (1957). The model is labeled the 'relative permanent income' theory of consumption. The key feature is that the share of permanent income devoted to consumption is a negative function of household relative permanent income. The model generates patterns of consumption spending consistent with both long-run time series data for aggregate consumption and empirical findings from cross-section data showing high-income households have a higher propensity to save. The model also explains why consumption inequality is less than income inequality.