Re: [Pen-l] The Ratchet Effect

[Jim Devine <jdevine03@xxxxxxxxx>]

Eugene Coyle wrote:
> What Duesenberry wrote about was the Demonstration Effect, not the Ratchet
> effect.  Very different.

he wrote about both. If I had the book here, I'd point out the role of
the latter.  In Duesenberry, the ratchet effect helps explain why the
marginal propensity to consume out of increases in income is higher
than the mpc out of decreases in income. (that is, if I get a $10,000
extra income in 2008, I might raise my consumption spending by $9,000,
but if my income falls by $10,000 in 2009, I would likely cut my
consumption by only $7,000.)

Among macroeconomists, this is has largely been replaced by the
"permanent income theory" of investment: if I expect my income to rise
by $10,000 next year and that it's likely to stay there (so it's
"permanent"), I raise my consumption spending by more than if I expect
that $10,000 to be transitory. While this forward-looking theory has
something to add, it's a mistake to forget Duesenberry's
"backward-looking" (or looking at the Jones) theory.

(In economics as in the beauty parlor, "permanent" does not mean forever.)
-- 
Jim Devine / "Segui il tuo corso, e lascia dir le genti." (Go your own
way and let people talk.) -- Karl, paraphrasing Dante.
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