Q. 15 In May and June of 2008, the fed... [FREE SOLUTION]

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Chapter 13: Q. 15 (page 297)

In May and June of $2008$ , the federal government issued one-time tax rebates - checks returning a small portion of taxes previously paid to millions of U.S residents, and U.S. real disposable income temporarily jumped by nearly $$ 500$ billion. Household real consumption spending did not increase in response to the short-lived increase in real disposable income. Explain how the logic of the permanent income hypothesis might help to account for this apparent non relationship between real consumption and real disposable income in the late spring of $2008$ .

Short Answer

Expert verified

Real consumption expenditure has not grown in response to the temporary gain in real disposable income.

Step by step solution

Introduction

The given is the details on the one-time tax rebates checks issued by the federal government

The objective is to explain the logic of permanent income hypothesis

Step 1

The permanent income hypothesis states that an individual's consumption flows are determined by his or her permanent income, which is nothing more than the expected long-term average income.

This logic may help to explain the apparent non relationship between real consumption and real disposable income in late spring $2008$ .

Step 2

Temporary increases in income have little impact on long-term average income and consequently have little impact on overall consumption spending.

In the spring of $2008$ , a similar event occurred when the government offered tax rebates.

Step 3

The rise in discretionary income is essentially transitory because these rebates are one-time measures. With little change in predicted long-term average income or permanent income, there has been no impact on consumption spending, and so real consumption expenditure has not grown as a result of the temporary gain in real disposable income.