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Marginal propensities to consume before and after the Great Recession

Yunho Cho, James Morley () and Aarti Singh ()

No 2019-11, Working Papers from University of Sydney, School of Economics

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.

Keywords: Marginal propensity to consume; Great Recession; consumption insurance; liquid wealth; house prices (search for similar items in EconPapers)
Date: 2019-07, Revised 2021-09
New Economics Papers: this item is included in nep-acc, nep-ias and nep-ure
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