Does Public Income Induce More Consumption?

The Life‐Cycle/Permanent Income Hypothesis predicts that income uncertainty reduces an individual’s incentive to consume, while holding permanent income level constant. This implies that switching from a relatively unstable form of income to a stable one motivates consumption. This article explores this implication by quantifying and comparing the marginal propensity to consume (MPC) out of private income and income from a public pension scheme. It exploits the introduction of a public pension that provides a monthly fixed amount of payment – a relatively secure source of income. The results suggest that the provision of pension leads to a higher MPC for the beneficiaries’ households, and the estimated MPC out of the pension income is significantly larger than the corresponding estimate for private income. Further examination suggests that households facing more non‐tradable risks appear to be more prudent on consumption, highlighting the role of income uncertainty in households’ consumption decisions.