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Using Subjective Income Expectations to Test for Excess Sensitivity of Consumption to Predicted Income Growth

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Abstract

We test for precautionary saving and excess sensitivity of consumption to predicted income growth using a 1989-93 panel survey of Italian households that has measures of subjective income and inflation expectations. These expectations provide a powerful instrument for predicting income growth. The empirical specification controls for predictable changes in labor supply and allows a fairly general specification for the stochastic structure of the forecast error. We find that consumption growth is positively correlated with the expected variance of income and uncorrelated with predicted income growth. Overall, the results support the precautionary saving model

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 12.

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Date of creation: 01 Dec 1998
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Publication status: Published in European Economic Review, February 2000, vol. 44, pages 337-358
Handle: RePEc:sef:csefwp:12

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Keywords: Subjective expectations; precautionary saving; excess sensitivity;

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