Abstract: Studies based on natural experiments find that consumption responds strongly and significantly to a transitory variation in income, while semi-structural estimations find no pass-through of transitory shocks to consumption. I develop a more robust semi-structural estimator that relaxes the assumption that log-consumption is a random walk. The robust pass-through estimate is significant and large, implying a yearly MPC of 0.32, close to the natural experiment findings. The robust estimator performs well in numerical simulations of a life-cycle model while non-robust estimators do not. The difference between the two in the simulations is similar to their difference in the survey data.
Forthcoming at AEJ:Macro
Formerly circulated as “How Does Consumption Respond to a Transitory Income Shock? Reconciling Natural Experiments and Structural Estimations”
with Richard Blundell, Margherita Borella & Mariacristina De Nardi
Abstract: In old age, consumption can fluctuate because of shocks to available resources and because health shocks affect utility from consumption. We find that even temporary drops in income and health are associated with drops in consumption and most of the effect of temporary drops in health on consumption stems from the reduction in the marginal utility from consumption that they generate. More precisely, after a health shock, richer households adjust their consumption of luxury goods because their utility of consuming them changes. Poorer households, instead, adjust both their necessary and luxury consumption because of changing resources and utility from consumption.