Milton Friedman’s permanent income hypothesis

Milton Friedman’s Permanent Income Hypothesis is now commonly used to argue the ineffectiveness of temporary expansionary fiscal policies because people save most of their transitory incomes. Friedman’s argument correctly builds upon Keynes’s treatment of saving as non-consumption. But savings are spent by borrowers, as Adam Smith explains: “What is annually saved is as regularly consumed as what is annually spent, and nearly at the same time too.” Thus, the failure of pure fiscal policy to affect aggregate demand for a closed economy is due to the government’s budget constraint. This chapter explains the distraction from Keynes’s misrepresentation of saving by Friedman.