The marginalization of absolute and relative income hypotheses of consumption and the role of fiscal policy

Abstract

Contrary to Keynes’ and Duesenberry’s consumption theories, absolute or relative income plays a minimal role in the life-cycle and in the permanent-income hypotheses. It plays an even lesser role in contemporary orthodox consumption functions which are extensions of these two theories in a rational-expectations framework. As a result, the theoretical effectiveness of fiscal policy for raising output is greatly diminished. The paper argues that Keynes’ and Duesenberry’s approaches were marginalised not because of their empirical or theoretical shortcomings, but because of emphasising the psychological and social influences on consumption patterns, and because of not employing the intertemporal utility maximising framework.