The budget constraint requires that, eventually, consumption must adjust fully to any permanent shock to income. Intuition suggests that, knowing this, optimizing agents will fully adjust their spending immediately upon experiencing a permanent shock. However, this paper shows that if consumers...

This paper argues that the modern stochastic consumption model, in which impatient consumers face uninsurable labor income risk, matches Milton Friedman's (1957) original description of the Permanent Income Hypothesis much better than the perfect foresight or certainty equivalent models did. The...

"Buffer-stock" versions of the dynamic stochastic optimizing model of saving are now standard in the consumption literature. This paper builds theoretical foundations for rigorous understanding of the main characteristics of buffer stock models, including the existence of a target level of...

Today’s dominant strain of macroeconomic models supposes that aggregate consumption can be understood by assuming the existence of a ‘representative agent’ whose behavior rationalizes observed outcomes. But representative agent models yield embarrassingly implausible (and empirically...