Reconsidering the Marginal Propensity to Consume Under Persistent Liquidity Constraints: Precautionary Saving Motives and the Erosion of the Permanent Income Hypothesis in Emerging Market Economies

Abstract

The Permanent Income Hypothesis (PIH) has long served as the cornerstone of consumption-smoothing theory, yet its empirical validity within emerging market economies remains contested, particularly under conditions of sustained liquidity constraints and macrofinancial volatility. This paper re-examines the marginal propensity to consume (MPC) using household-level panel data from six middle-income economies spanning 2010–2023, employing a two-stage instrumental variable estimator augmented with time-varying precautionary saving controls. Our findings reveal statistically significant deviations from PIH predictions, with estimated MPCs systematically exceeding life-cycle benchmarks among liquidity-constrained quintiles. These results challenge the structural robustness of the PIH in non-OECD contexts and carry substantial implications for fiscal multiplier calibration, targeted transfer policy design, and macroprudential regulatory frameworks.