Re: [Pen-l] Duesenberry

[Jim Devine <jdevine03@xxxxxxxxx>]

maybe; it's quite possible my memory has failed me again. I don't
remember this article being discussed, while I do remember JD being a
pen-l topic.

On Fri, May 8, 2009 at 7:17 AM, Eugene Coyle <eugenecoyle@xxxxxxx> wrote:
> This was discussed on Pen-l in the past.  You been googling the archive?
>
> Gene Coyle
>
>
> On May 8, 2009, at 6:14 AM, Jim Devine wrote:
>
>> an interesting article, found while googling
>>
>> New York TIMES / June 9, 2005
>> The Mysterious Disappearance of James Duesenberry
>> By ROBERT H. FRANK
>>
>> UNLESS you are a professional economist nearing retirement, the name
>> James S. Duesenberry is probably unfamiliar. By itself, that is
>> unsurprising, because he wrote primarily for academic audiences while
>> on the Harvard economics faculty from 1946 to 1989. The real surprise
>> is that most academic economists under 50 have also never heard of Mr.
>> Duesenberry.
>>
>> This is puzzling because his theory of consumer behavior clearly
>> outperforms the alternative theories that displaced it in the 1950's -
>> a striking reversal of the usual pattern in which theories are
>> displaced by alternatives that better explain the evidence. His
>> disappearance from modern economics textbooks is an intriguing
>> cautionary tale in the sociology of knowledge.
>>
>> But it also has important practical implications. Unless we understand
>> what drives consumption, which makes up two-thirds of total economic
>> activity, we cannot predict how people will respond to policy changes
>> like tax cuts or Social Security privatization.
>>
>> Any successful consumption theory must accommodate three basic
>> patterns: the rich save at higher rates than the poor; national
>> savings rates remain roughly constant as income grows; and national
>> consumption is more stable than national income over short periods.
>>
>> The first two patterns appear contradictory: If the rich save at
>> higher rates, savings rates should rise over time as everyone becomes
>> richer. Yet this does not happen.
>>
>> Mr. Duesenberry's explanation of the discrepancy is that poverty is
>> relative. The poor save at lower rates, he argued, because the higher
>> spending of others kindles aspirations they find difficult to meet.
>> This difficulty persists no matter how much national income grows, and
>> hence the failure of national savings rates to rise over time.
>>
>> To explain the short-run rigidity of consumption, Mr. Duesenberry
>> argued that families look not only to the living standards of others,
>> but also to their own past experience. The high standard enjoyed by a
>> formerly prosperous family thus constitutes a frame of reference that
>> makes cutbacks difficult, which helps explain why consumption levels
>> change little during recessions. [except when incomes & the access to
>> credit fall drastically at the same time that consumer-owned assets
>> lose value, as recently.]
>>
>> Despite Mr. Duesenberry's apparent success, many economists felt
>> uncomfortable with his relative-income hypothesis, which to them
>> seemed more like sociology or psychology than economics. The
>> profession was therefore immediately receptive to alternative theories
>> that sidestepped those disciplines. Foremost among them was Milton
>> Friedman's permanent-income hypothesis, which still dominates research
>> on spending.
>>
>> Mr. Friedman argued that a family's current spending depends not on
>> its current income, but rather on its long-run average, or permanent,
>> income. Because economic theory predicts that people prefer steady
>> consumption paths to highly variable ones, Mr. Friedman argued that
>> people would smooth their spending - saving windfall income gains and
>> drawing down savings to cover windfall losses. Consumption should thus
>> be more stable than income over short periods.
>>
>> Mr. Friedman also argued that a family's savings rate should be
>> independent of its income, leading him to predict the long-run
>> stability of national savings rates.
>>
>> Mr. Friedman dismissed the high savings rates of the rich as a
>> statistical artifact. Because many of those with high measured incomes
>> in any given year will have enjoyed positive windfalls, their
>> permanent incomes will be lower, on average, than their measured
>> incomes for that year. So if they save windfall gains, they will save
>> a higher proportion of their measured incomes than of their permanent
>> incomes. The converse holds for those with low measured incomes in any
>> given year, who will have experienced a preponderance of windfall
>> losses that year.
>>
>> Although it is a tidy story, its fundamental premises are contradicted
>> by the data. As numerous careful studies have shown, for example,
>> savings rates rise sharply with permanent income. Mr. Friedman's
>> defenders responded by arguing that rich consumers want to bequeath
>> money to their children. But why should the poor lack this motive?
>> Another problem is that people consume windfall income at almost the
>> same rate as permanent income. To this, Mr. Friedman responded that
>> consumers appear to have unexpectedly short planning horizons. But if
>> so, then consumption does not really depend primarily on permanent
>> income.
>>
>> Strangest of all, Mr. Friedman's theory assumes that context has
>> absolutely no effect on judgments about living standards. It predicts,
>> for example, that an investment banker will remain equally satisfied
>> with his twin-engine Cessna, even after discovering that his new
>> summer neighbor commutes to Nantucket in an intercontinental
>> Gulfstream jet.
>>
>> In light of abundant evidence that context matters, it seems fair to
>> say that Mr. Duesenberry's theory rests on a more realistic model of
>> human nature than Mr. Friedman's. It has also been more successful in
>> tracking actual spending. And yet, as noted, it is no longer even
>> mentioned in leading textbooks.
>>
>> What is going on here? The psychologist Tom Gilovich has suggested
>> that someone who wants to accept a hypothesis tends to ask, "Can I
>> believe it?" In contrast, someone who wants to reject it tends to ask,
>> "Must I believe it?" Most economists, it appears, just never wanted to
>> believe the relative-income hypothesis - perhaps because it suggests
>> the possibility of wasteful spending races.
>>
>> But whatever the original reason for Mr. Duesenberry's disappearance,
>> the profession's mood seems to be changing. As evidenced by the Nobel
>> Prize in economics having been awarded to a psychologist, Daniel
>> Kahneman, in 2002, economists are showing new receptiveness to
>> insights from other social sciences.
>>
>> Professor Duesenberry, now 86, is alive and well in Cambridge, Mass.
>> His theory is ripe for a second look.
>>
>> Robert H. Frank, an economist at the Johnson School of Management at
>> Cornell University, is the author of "Luxury Fever."
>>
>> [Francis Green has argued that in terms of econometrics, Duesenberry's
>> theory does as well as if not better than the alternative.]
>> -- Jim Devine / "If heart-aches were commercials, we'd all be on TV." --
>> John Prine
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-- 
Jim Devine / "If heart-aches were commercials, we'd all be on TV." -- John Prine
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