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The Economic Effects of Short-Run Macro Stimulus

1 min readBy: Gerald Prante

President Bush has put forth a stimulus package designed to increase short-run consumption in the macroeconomy. Something is likely to happen given that the Democratic leadership in Congress appears to be on board with trying to stimulate the weakening economy.

But does it work? Under a pure rational expectations economic theory, it may not work. Other theories explain how it could. What does the empirical literature say? For those interested, here is a collection of academic research on the topic from Keynes to Carroll. References provided by David Romer’s Advanced Macroeconomics textbook, chapter 7 entitled “Consumption.”

Keynes’s General Theory, see chapters 8-10

Friedman’s Permanent Income Hypothesis (Friedman’s first major contribution to economics) – book published in 1957

A Theory of the Consumption Function

Brief Review of Friedman’s PIH

Overview of PIH

Modigliani’s and Ando’s famous Life Cycle Theory:

“The Life Cycle Hypothesis of Saving: Aggregate Implications and Tests.” American Economic Review 53 (March 1963): 55-84.

Robert Hall’s works on consumption:

“Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence.” Journal of Political Economy 86 (December): 971-987.

“Intertemporal Substitution in Consumption.” JPE 96 (October): 921-947.

Tests of Hall’s Work:

Campbell and Mankiw. “Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence.” NBER Macroeconomics Annual 4: 185-216.

Shea, John. 1995. “Union Contracts and the Life-Cycle/Permanent-Income Hypothesis.” American Economic Review 85 (March): 186-200.

Chris Carroll and Lawrence Summers evidence against PIH:

Carroll and Summers. 1991. “Consumption Growth Parallels Income Growth: Some New Evidence.” In B. Douglas Bernheim and John B. Shoven, eds, National Saving and Economic Performance, 305-343. Chicago: University of Chicago Press.

Other works by Carroll:

1992. “The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence.” Brookings Papers on Economic Activity, no. 2, 61-156.

1997. “Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis.” Quarterly Journal of Economics 112 (February): 1-55.