Permanent and Transitory Income Effects

Abstract

T HE last few decades have seen the presentation of a number of new savings theories. Traditionally these theories are grouped under the permanent income, relative income, and absolute income hypotheses. This paper will try to combine ideas from the permanent and absolute theories in order to obtain estimates of the transitory and the permanent income effects.' We will emphasize cross section problems, but our suggestions will also be appropriate to time series analysis. In section II, we will integrate the permanent and absolute savings theories. In section III, we will define normal income as a distributed lag in incomes and use a Koyck transformation to obtain an equation that yields separate estimates of the transitory and permanent (normal) marginal propensities to save. The section will include a discussion of statistical problems in using the Koyck transformation. In section IV, we will use different types of averages to define normal income; then we will derive the relevant savings functions. In the last section, we will present and compare empirical results using all the definitions of normal income.