Disentangling Insurance and Information in Intertemporal Consumption Choices

Abstract

The textbook version of the life-cycle perma-nent income hypothesis with no liquidity con-straints predicts that consumption should react very mildly to (unanticipated) transitory income changes and very strongly to permanent ones. This prediction has important policy implica-tions in understanding the response of consum-ers to tax rebates or increases that are made for stabilization purposes. In recent years there has been a resurgence of interest in estimating these important parameters, either using quasi-experimental data (such as randomization of the timing when tax rebate checks are received by households; see David Johnson, Jonathan Parker, and Nicholas Souleles 2006), or imposing struc-tural restrictions on the stochastic income pro-cess faced by consumers (Orazio Attanasio and Nicola Pavoni 2008; Richard Blundell, Luigi Pistaferri, and Ian Preston 2008; Jonathan Heathcote, Kjetil Storesletten, and Giovanni L. Violante 2007; Giorgio Primiceri and Thijs van Rens, forthcoming).The main objection of quasi-experimental stud-ies is that the results may be context-specific. The main problem with the second strand of the litera-ture is that estimates of the response of consump -tion to income shocks may confound two issues, insurance and information. On the one hand, the estimate reflects the ability (or lack thereof) of the household to smooth consumption through a variety of channels, such as self-insurance, gov -ernment-provided insurance, credit markets, or other informal mechanisms. On the other hand, the identification strategy requires the ability to statistically separate what is a shock from what is an anticipated event (when seen from the point of