How Do Households Respond to Income Shocks?

Dirk Krueger, Egor Malkov and Fabrizio Perri

No 655, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: We use panel data from the Italian Survey of Household Income and Wealth from 1991 to 2016 to document empirically what components of the household budget constraint change in response to shocks to household labor income, both over shorter and over longer horizons. We show that shocks to labor income are associated with negligible changes in transfers and non-labor income components, modest changes in consumption expenditures, and large changes in wealth. We then split the sample in households which do not own business or real estate wealth, and households who do. For the first group, we find that consumption responses are more substantial (and increasing with the horizon of the income shock) and wealth responses are much smaller. We show that, for this group, a version of the standard PIH framework that allows for partial insurance against even permanent income shocks can explain well the consumption and wealth responses, both at short and long horizons. For the second group the standard framework cannot explain the large changes in wealth associated with income shocks. We conclude that models which include shocks to the value of household wealth are necessary to fully evaluate the sources and the consequences of household resource risk.

Keywords: Partial insurance; Income shocks; Consumption; Permanent income hypothesis; Liquid wealth (search for similar items in EconPapers)
JEL-codes: D91 E21 (search for similar items in EconPapers)
Date: 2023-12-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: How Do Households Respond to Income Shocks? (2024)
Working Paper: How Do Households Respond to Income Shocks? (2023)
Working Paper: How Do Households Respond to Income Shocks? (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:97506

DOI: 10.21034/sr.655

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