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The Consumption Response to Predictable Changes in Discretionary Income: Evidence from the Repayment of Vehicle Loans

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  • Melvin Stephens

    (Carnegie Mellon University and National Bureau of Economic Research)

Abstract

Although the life cycle/permanent income hypothesis is the primary framework for understanding household consumption and savings decisions, only a few studies have used clearly identifiable income changes to test the basic predictions of the model. The estimates produced using this empirical strategy have yet to lead to a consensus of beliefs since the results have both favored and rejected the model. This paper contributes to this literature by examining the consumption reaction to predictable increases in discretionary income following the final payment of a vehicle loan. Using data from the Consumer Expenditure Survey, the results show that a 10% increase in discretionary income due to a loan repayment leads to a 2% to 3% increase in nondurable consumption. Additional analysis suggests that these findings may be explained by the presence of borrowing constraints. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Suggested Citation

  • Melvin Stephens, 2008. "The Consumption Response to Predictable Changes in Discretionary Income: Evidence from the Repayment of Vehicle Loans," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 241-252, May.
  • Handle: RePEc:tpr:restat:v:90:y:2008:i:2:p:241-252
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    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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