Can Marginal Propensity to Consume be Zero?

Most mainstream economists tell us that the Marginal Propensity to Consume cannot be zero. That is of course not true! This is one of the reasons why mainstream economists often go wrong. But first what is Marginal Propensity to Consume?

Marginal Propensity to Consume (MPC) is the fraction of the next Rupee earned, that an individual/household shall use in consumption of goods and services. Thus if MPC is equal to 0.8, it means that if the income of an individual goes up by Rs. 1/-, the individual shall spend 80 paisa and save 20 paisa.

Now, mainstream economists believe that MPC cannot be Zero. Thus if there is an additional income, part of it shall surely go into consumption. Notice, how fiscal stimuli plans are often based on this premise. Reduce taxes and part of the disposable income shall go in increased consumption. Hand over money (Bush style) and part of it will come back as consumption expenditure.

Are the mainstream economists correct in their belief? Consider a falling economy with job cuts all around. Lets take the case of a person who still has a job, in fact gets either an increment (or a Bush style $600 paycheck). Let us assume that this person also has a home loan to pay. With falling home prices and with people being fired all around him, would he consider spending part of the extra money in buying something or will he save it for a rainy day. I suspect it shall be the latter. If so, mainstream economists are far away from the truth. No wonder they are unable to understand why people did not go shopping when Bush handed them cheques. They were unable to figure out in advance that savings rate in US will go up under the circumstances.

As a conclusion, in stressed conditions, in the short run, MPC can indeed be zero. Any attempt at fiscal expansion is therefore, unlikely to yield results in such conditions.