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Marginal propensities to consume before and after the Great Recession

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  • Cho, Yunho
  • Morley, James
  • Singh, Aarti

Abstract

We extend a semi-structural model of household income and consumption to allow for dynamic consumption elasticities with respect to transitory income shocks. Likelihood-based inference for our model accurately estimates consumption insurance against income shocks in simulated data from a life-cycle model with borrowing constraints and captures non-zero transitory consumption responses for constrained households. Applying our model to data from a representative sample of U.S. households, we find that short-run elasticities with respect to transitory income shocks are substantially larger than long-run elasticities. We also find a structural break in the transitory sensitivity of consumption from before to after the Great Recession, implying an increase in the estimated marginal propensity to consume out of transitory income for all households by more than 40%. There is considerable heterogeneity in estimates across households grouped by various balance sheet characteristics, with the significant increase in transitory sensitivity of consumption for all households driven by homeowners with lower levels of liquid wealth. Our estimates also imply large consumption elasticities with respect to house prices, supporting a bigger role of the deterioration in housing wealth for liquidity-constrained homeowners than deleveraging in explaining the fall in consumption during the Great Recession.

Suggested Citation

  • Cho, Yunho & Morley, James & Singh, Aarti, 2019. "Marginal propensities to consume before and after the Great Recession," Working Papers 2019-11, University of Sydney, School of Economics, revised Sep 2021.
  • Handle: RePEc:syd:wpaper:2019-11
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    Cited by:

    1. Koval, Pavel & Polbin , Andrey, 2020. "Evaluation of permanent and transitory shocks role in consumption and income dynamics in the Russian Federation," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 57, pages 6-29.
    2. Kartik B. Athreya & Ryan Mather & Jose Mustre-del-Rio & Juan M. Sanchez, 2019. "The Effects of Macroeconomic Shocks: Household Financial Distress Matters," Working Papers 2019-025, Federal Reserve Bank of St. Louis, revised 11 Sep 2023.
    3. Kartik B. Athreya & Ryan Mather & Jose Mustre-del-Rio & Juan M. Sanchez, 2019. "Consumption in the Great Recession: The Financial Distress Channel," Working Paper 19-13, Federal Reserve Bank of Richmond.
    4. Jorge Miranda-Pinto & Daniel P. Murphy & Kieran Walsh & Eric Young, 2020. "Saving Constraints, Debt, and the Credit Market Response to Fiscal Stimulus," Working Papers 20-07, Federal Reserve Bank of Cleveland.
    5. Fiona Price & Benjamin Beckers & Gianni La Cava, 2019. "The Effect of Mortgage Debt on Consumer Spending: Evidence from Household-level Data," RBA Research Discussion Papers rdp2019-06, Reserve Bank of Australia.

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    Keywords

    Marginal propensity to consume; Great Recession; consumption insurance; liquid wealth; house prices;
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