Consumption Adjustment under Time-Varying Income Uncertainty

Abstract

We study the effect of income uncertainty on consumption in a model that includes precautionary saving. In contrast to previous studies, we focus on time-series variation in income uncertainty. Our time-series measure of income uncertainty is constructed from a panel of forecasts. We find evidence of precautionary saving in that increases in income uncertainty are related to increases in aggregate rates of saving. We also find evidence that anticipated income growth rates have less explanatory power for consumption growth rates after conditioning on income uncertainty. The evidence indicates the presence of forward-looking consumers who gradually adjust precautionary savings in response to changing income uncertainty.