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How does Household Consumption Respond to Income Shocks? Evidence and Theory

  • Fabrizio Perri

    (University of Minnesota)

  • Dirk Krueger

    (University of Pennsylvania)

n this paper we first use the Italian Survey of Household Income and Wealth to document how various household choices (including consumption and wealth) change in response to an income change. We show that these responses are not consistent with simple benchmark models (i.e. complete markets or hands to mouth consumers). In particular, we find evidence of significant asymmetries in how consumption and wealth respond to income change. We also find that these responses have changed significantly over time. We then explore how existing partial risk sharing models can account for this evidence. Preliminary work suggest that such a model, especially if one wants to explain more recent data, will have to include better insurance means than the standard incomplete markets but substantially less than a model with a full set of contingent assets.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 910.

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Date of creation: 2008
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Handle: RePEc:red:sed008:910
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  1. Fatih Guvenen, 2007. "An Empirical Investigation of Labor Income Processes," NBER Working Papers 13394, National Bureau of Economic Research, Inc.
  2. Fernando Alvarez & Urban J. Jermann, 1999. "Quantitative asset pricing implications of endogenous solvency constraints," Working Papers 99-5, Federal Reserve Bank of Philadelphia.
  3. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
  4. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  5. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2009. "Consumption and labor supply with partial insurance: an analytical framework," Staff Report 432, Federal Reserve Bank of Minneapolis.
  6. Zhang, H.H., 1995. "Endogenous Borrowing Constraints with Incomplete Markets," GSIA Working Papers 1995-25, Carnegie Mellon University, Tepper School of Business.
  7. Gervais, Martin & Klein, Paul, 2009. "Measuring consumption smoothing in CEX data," Discussion Paper Series In Economics And Econometrics 0906, Economics Division, School of Social Sciences, University of Southampton.
  8. Angus Deaton, 1989. "Saving and Liquidity Constraints," NBER Working Papers 3196, National Bureau of Economic Research, Inc.
  9. Fatih Guvenen, 2004. "Learning your Earning: Are Labor Income Shocks Really That Persistent?," 2004 Meeting Papers 177, Society for Economic Dynamics.
  10. Orazio Attanasio & Steven J. Davis, 1994. "Relative Wage Movements and the Distribution of Consumption," NBER Working Papers 4771, National Bureau of Economic Research, Inc.
  11. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244, March.
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