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

Fabrizio Perri and Dirk Krueger

No 910, 2008 Meeting Papers from Society for Economic Dynamics

Abstract: 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.

Date: 2008
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