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Can Consumers Distinguish Persistent from Transitory Income Shocks?

Author

Listed:
  • Jeppe Druedahl

    (CEBI, Department of Economics, University of Copenhagen)

  • Thomas H. Joergensen

    (CEBI, Department of Economics, University of Copenhagen)

Abstract

We study whether households can distinguish persistent from transitory income shocks, and the implications for consumption-saving behavior. We construct a novel consumption-saving model where the household must infer the persistent component of its income process from actual income realizations together with an additional noisy private signal. We first show that the degree of imperfect information has important consequences for the interpretation of transmission parameters to persistent and transitory income shocks. A large transitory transmission parameter can e.g. be estimated despite of a low marginal propensity to consume because the short run covariance between income growth and consumption growth increases when households cannot distinguish persistent from transitory income shocks. We further show that the households� degree of knowledge can be identified from panel data on income and consumption. Finally, we estimate a high degree of knowledge in the Panel Study of Income Dynamics.

Suggested Citation

  • Jeppe Druedahl & Thomas H. Joergensen, 2018. "Can Consumers Distinguish Persistent from Transitory Income Shocks?," CEBI working paper series 18-03, University of Copenhagen. Department of Economics. The Center for Economic Behavior and Inequality (CEBI).
    • Handle: RePEc:kud:kucebi:1803
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    File URL: https://www.econ.ku.dk/cebi/publikationer/working-papers/CEBI-WP-03-18.pdf
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    More about this item

    Keywords

    Consumption; Saving; Income Shocks; Learning; Consumer Information;
    All these keywords.

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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