Is There Heterogeneity in the Response of Consumption to Income Shocks?

Abstract

While recently more and more research has focused on the aggregate response of consumption to income shocks, little is known about how this response differs for households at different ends of the income distribution. This paper investigates how consumption reacts to transitory and permanent shocks to disposable income for households with an income above or below the median. Panel data on income and consumption from the PSID between 1998 and 2012 is used to estimate consumption insurance parameters. Although households below the median are found to be exposed to larger transitory and permanent income shocks, they can buffer permanent shocks to income significantly better compared to households above the median. The latter, though, are better insured against transitory income shocks. In general, the poorer households are, the more similarly they react to the two kinds of income shocks.