Windfall Income Shocks with Finite Planning Horizons

Denis Gorea

Staff Working Papers from Bank of Canada

Abstract: How do households respond to unanticipated income shocks? I build and estimate a quantitative model of bounded rationality in which reoptimization is costly. Households respond to windfall income shocks by choosing a finite planning horizon over which to reoptimize. The optimal horizon is increasing in income, wealth, and the magnitude of the income shock. In the estimated model, the distribution of consumption responses is consistent with two motivating facts: highly liquid households have large consumption responses out of income shocks that cannot be driven by borrowing constraints, and larger income shocks induce smaller consumption responses.

Keywords: Domestic demand and components; Economic models; Fiscal policy (search for similar items in EconPapers)
JEL-codes: D91 E21 G51 (search for similar items in EconPapers)
Pages: 62 pages
Date: 2022-09
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:22-40

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