ROBERTHALLANDTHERANDOM-
WALKHYPOTHESI
S
The per manent-i
ncome hy pothesisi s based on Fisher ’
s modelof
i
ntert
empor alchoi ce.I t bui l
ds on t he idea t hat forwar d-l
ooking
consumer sbaset heirconsumpt i
ondeci si
onsnotonl yont heircurrent
i
ncomebutal soont heincomet heyexpecttor ecei
veinthef uture.Thus,
thepermanent -i
ncomehy pot hesishighli
ghtsthatconsumpt i
ondepends
on peopl e’
s expect at
ions. Recent r esearch on consumpt ion has
combinedt hisv i
ew oft heconsumerwi ththeassumpt ionofr ati
onal
expectati
ons.Ther ati
onal-ex pectati
onsassumpt i
onst at
est hatpeopl e
use al l avai
lable infor
mat i
on t o make opt imal forecast s. This
assumpt i
oncanhav eprof oundi mpl i
cati
onsf orthecost sofst opping
i
nflat
ion.I tcan al so hav e pr ofound impli
cat i
ons f
ort he st udy of
consumerbehav i
or.
TheHy
pot
hesi
s
Theeconomi stRober tHallwast hef i
rsttoderivet heimplicat
ionsof
rat
ionalexpectati
onsf orconsumpt ion.Heshowedt hatifthepermanent
-i
ncome hy pothesis is correct
,and i f consumer s hav e rati
onal
expectati
ons,t hen changes i n consumpt ion ov ert i
me shoul d be
unpredict
able.Whenchangesi nav ari
ableareunpr edict
able,t
hev ari
able
i
ssai dtofol
lowar andom walk.AccordingtoHal l
,thecombi nati
onoft he
permanent-i
ncomehy pot
hesisand r ati
onalexpect ati
onsi mpli
est hat
consumpt i
onf oll
owsar andom wal k.
Hallr easoned as f ollows. Accor ding t o the per manent -i
ncome
hypothesis,consumer sf acef luctuatingi ncomeandt r
yt heirbestt o
smoot ht heirconsumpt ion ov ert i
me.Atany moment ,consumer s
choose consumpt ion based on t heircur rentexpect ati
ons oft heir
l
ifet
imei ncomes.Ov ert ime,t heychanget hei
rconsumpt i
onbecause
theyreceivenewst hatcausest hem t or evisetheirexpectations.For
exampl e, a person get ti
ng an unex pected promot i
on i ncreases
consumpt ion,wher eas a per son get ti
ng an unexpect ed demot i
on
decreasesconsumpt i
on.I not herwor ds, changesinconsumpt ionreflect
“sur
prises”aboutlifeti
mei ncome.I fconsumer sar eoptimallyusingal l
avai
lableinformati
on,t hent heyshoul dbesur pri
sedonl ybyev entsthat
were entirel
yunpr edictable.Ther efore,changes i nt heirconsumpt i
on
shouldbeunpr edi
ctableaswel l
.
, I
mpl
i
cat
ions
Therational-expectati
onsappr oacht oconsumpt ionhasi mpli
cationsnot
onlyforf orecasti
ngbutal sof ort heanalysisofeconomi cpol i
ci es.I f
consumer sobeyt hepermanent -
incomehy pot
hesisandhav er ational
expectati
ons, t hen onl y unexpect ed pol i
cy changes i nfluence
consumpt ion.These policy changes t ake ef f
ectwhen t hey change
expectati
ons.Forexampl e,supposet hattodayCongr esspassesat ax
i
ncreaset obeef fecti
venexty ear.Inthiscase,consumer sr eceiv et he
newsaboutt hei
rlifet
imei ncomeswhenCongr esspassest hel aw ( or
evenear li
eri fthel aw’spassagewaspr edict
able).
Thear rivaloft his
newscausesconsumer st or evi
set heirexpectati
onsandr educet hei r
consumpt ion.Thef oll
owingy ear ,whent het axhi kegoesi ntoef fect,
consumpt ionisunchangedbecausenonewshasar ri
ved.
Hence, ifconsumershav erati
onalexpectati
ons,
policy
makersinf
luence
theeconomynotonl ythroughtheiracti
onsbutalsothrought
hepublic’
s
expectati
onoft hei
ractions.Expectati
ons,however
,cannotbeobserved
dir
ectl
y.Therefor
e,itisof t
enhar dt oknow how andwhenchangesi n
fi
scalpolicyal
teraggregatedemand.
I
rvi
ngFi
sherandI
nter
tempor
alChoi
ce
The economi st Ir
v i
ng Fi sher dev eloped t he model wi th whi ch
economi st
s analyze how r at
ional,forwar d-
looki ng consumers make
i
ntertempor alchoices— t hati s,choicesi nvolv i
ngdi ff
erentperiodsof
ti
me.Fi sher’
smodeli ll
umi natestheconst raintsconsumer sface,t he
preferences theyhav e,and how t hese const raint
s and preferences
togetherdet er
minet heirchoicesaboutconsumpt ionandsaving.
Mostpeopl ewoul dprefertoincr
easet hequant i
tyorqualit
yoft hegoods
andser vi
cestheyconsume.Ther easonpeopl econsumel esst hanthey
desireisthattheirconsumpt i
onisconst r
ainedbyt hei
rincome.I nother
wor ds,consumer sfaceal i
mitonhow mucht heycanspend,cal l
eda
budgetconst r
aint.Whent heyaredecidinghowmucht oconsumet oday
versushow mucht osav eforthef utur
e,t heyf aceani nt
ertempor al
budgetconst raint
,whi ch measurest het otalresourcesav ailabl
ef or
consumpt ion todayand i nt he fut
ure.The f irststep in dev el
oping
Fisher’
smodel istoexami nethisconstrai
nt.
Letusexami ne t
he deci
sion f
acing a consumerwho liv
esfortwo
peri
ods.Per
iodonerepresentstheconsumer ’syout
h,andperi
odtwo
repr
esent
stheconsumer’soldage.TheconsumerearnsincomeY1and
WALKHYPOTHESI
S
The per manent-i
ncome hy pothesisi s based on Fisher ’
s modelof
i
ntert
empor alchoi ce.I t bui l
ds on t he idea t hat forwar d-l
ooking
consumer sbaset heirconsumpt i
ondeci si
onsnotonl yont heircurrent
i
ncomebutal soont heincomet heyexpecttor ecei
veinthef uture.Thus,
thepermanent -i
ncomehy pot hesishighli
ghtsthatconsumpt i
ondepends
on peopl e’
s expect at
ions. Recent r esearch on consumpt ion has
combinedt hisv i
ew oft heconsumerwi ththeassumpt ionofr ati
onal
expectati
ons.Ther ati
onal-ex pectati
onsassumpt i
onst at
est hatpeopl e
use al l avai
lable infor
mat i
on t o make opt imal forecast s. This
assumpt i
oncanhav eprof oundi mpl i
cati
onsf orthecost sofst opping
i
nflat
ion.I tcan al so hav e pr ofound impli
cat i
ons f
ort he st udy of
consumerbehav i
or.
TheHy
pot
hesi
s
Theeconomi stRober tHallwast hef i
rsttoderivet heimplicat
ionsof
rat
ionalexpectati
onsf orconsumpt ion.Heshowedt hatifthepermanent
-i
ncome hy pothesis is correct
,and i f consumer s hav e rati
onal
expectati
ons,t hen changes i n consumpt ion ov ert i
me shoul d be
unpredict
able.Whenchangesi nav ari
ableareunpr edict
able,t
hev ari
able
i
ssai dtofol
lowar andom walk.AccordingtoHal l
,thecombi nati
onoft he
permanent-i
ncomehy pot
hesisand r ati
onalexpect ati
onsi mpli
est hat
consumpt i
onf oll
owsar andom wal k.
Hallr easoned as f ollows. Accor ding t o the per manent -i
ncome
hypothesis,consumer sf acef luctuatingi ncomeandt r
yt heirbestt o
smoot ht heirconsumpt ion ov ert i
me.Atany moment ,consumer s
choose consumpt ion based on t heircur rentexpect ati
ons oft heir
l
ifet
imei ncomes.Ov ert ime,t heychanget hei
rconsumpt i
onbecause
theyreceivenewst hatcausest hem t or evisetheirexpectations.For
exampl e, a person get ti
ng an unex pected promot i
on i ncreases
consumpt ion,wher eas a per son get ti
ng an unexpect ed demot i
on
decreasesconsumpt i
on.I not herwor ds, changesinconsumpt ionreflect
“sur
prises”aboutlifeti
mei ncome.I fconsumer sar eoptimallyusingal l
avai
lableinformati
on,t hent heyshoul dbesur pri
sedonl ybyev entsthat
were entirel
yunpr edictable.Ther efore,changes i nt heirconsumpt i
on
shouldbeunpr edi
ctableaswel l
.
, I
mpl
i
cat
ions
Therational-expectati
onsappr oacht oconsumpt ionhasi mpli
cationsnot
onlyforf orecasti
ngbutal sof ort heanalysisofeconomi cpol i
ci es.I f
consumer sobeyt hepermanent -
incomehy pot
hesisandhav er ational
expectati
ons, t hen onl y unexpect ed pol i
cy changes i nfluence
consumpt ion.These policy changes t ake ef f
ectwhen t hey change
expectati
ons.Forexampl e,supposet hattodayCongr esspassesat ax
i
ncreaset obeef fecti
venexty ear.Inthiscase,consumer sr eceiv et he
newsaboutt hei
rlifet
imei ncomeswhenCongr esspassest hel aw ( or
evenear li
eri fthel aw’spassagewaspr edict
able).
Thear rivaloft his
newscausesconsumer st or evi
set heirexpectati
onsandr educet hei r
consumpt ion.Thef oll
owingy ear ,whent het axhi kegoesi ntoef fect,
consumpt ionisunchangedbecausenonewshasar ri
ved.
Hence, ifconsumershav erati
onalexpectati
ons,
policy
makersinf
luence
theeconomynotonl ythroughtheiracti
onsbutalsothrought
hepublic’
s
expectati
onoft hei
ractions.Expectati
ons,however
,cannotbeobserved
dir
ectl
y.Therefor
e,itisof t
enhar dt oknow how andwhenchangesi n
fi
scalpolicyal
teraggregatedemand.
I
rvi
ngFi
sherandI
nter
tempor
alChoi
ce
The economi st Ir
v i
ng Fi sher dev eloped t he model wi th whi ch
economi st
s analyze how r at
ional,forwar d-
looki ng consumers make
i
ntertempor alchoices— t hati s,choicesi nvolv i
ngdi ff
erentperiodsof
ti
me.Fi sher’
smodeli ll
umi natestheconst raintsconsumer sface,t he
preferences theyhav e,and how t hese const raint
s and preferences
togetherdet er
minet heirchoicesaboutconsumpt ionandsaving.
Mostpeopl ewoul dprefertoincr
easet hequant i
tyorqualit
yoft hegoods
andser vi
cestheyconsume.Ther easonpeopl econsumel esst hanthey
desireisthattheirconsumpt i
onisconst r
ainedbyt hei
rincome.I nother
wor ds,consumer sfaceal i
mitonhow mucht heycanspend,cal l
eda
budgetconst r
aint.Whent heyaredecidinghowmucht oconsumet oday
versushow mucht osav eforthef utur
e,t heyf aceani nt
ertempor al
budgetconst raint
,whi ch measurest het otalresourcesav ailabl
ef or
consumpt ion todayand i nt he fut
ure.The f irststep in dev el
oping
Fisher’
smodel istoexami nethisconstrai
nt.
Letusexami ne t
he deci
sion f
acing a consumerwho liv
esfortwo
peri
ods.Per
iodonerepresentstheconsumer ’syout
h,andperi
odtwo
repr
esent
stheconsumer’soldage.TheconsumerearnsincomeY1and
