I was educated that one should not use contractions in writing unless it is in dialogue. For example: Joe did not want to tell his wife the truth. He knew it was just a chance for her to go into one of her famous fits, and he could not put up with that. Is the way to write instead of Joe didn't want to tell his wife the truth. He knew it was just a chance to go into one of her famous fits, and he couldn't put with that. Or does it not matter and up to individual choice?
I suppose it depends on the tone you are trying to set. If you are looking to come across as more formal the first one would be the way to go. If you want your readers to feel like you are spinning them a yarn then the more causual style of number two might be a better fit.
If I'm writing in first person, then it's pretty much all dialogue. Third person would be no contractions outside of dialogue. Second person would be the one where it may go either way?
I want to say I was taught it in a college class on grammar, but I can't remember. I know that if you're doing non-fiction, you do shouldn't use contractions.
First/second/third person really doesn't have anything to do with what you're asking about. Any one of these three can be as formal or as informal as it needs to be. I've never heard of this as a rule, and I think if you look at any nonfiction book, you'll find plenty of contractions. I happen to be in a middle of reading a fairly serious nonfiction book, the type with all manner of footnotes and references ("Chief Engineer: Washington Roebling, the Man Who Built the Brooklyn Bridge"), opened it to the page where I left off, and the first sentence I happened to see reads "Only now was the terrible war coming to its close, those who'd fought it might think" -- not "who had."
We've come a ways since contractions were considered slang. There are certainly places where I would consider not using contractions, but it would be a matter of the tone I was trying to set, not a question of whether I was abiding by or straying from "the norm". I could be wildly off-base, but I suspect that unless you're writing in the style of a Regency Romance or something of the sort, most readers aren't even going to notice.
I never heard about this convention, but it would make sense if your narrator is being formal. If the narrator is an active part of the story, it would seem off though. Their narration would be taken as more conversational.