Keep Calm and Consume? Subjective Uncertainty and Precautionary Savings

Abstract

This paper estimates the effect of income uncertainty on assets held in accounts and cash, and finds substantial empirical evidence for precautionary savings. Using household-level panel data, it explicitly distinguishes between ‘real’ income uncertainty the household is actually exposed to, and ‘perceived’ income uncertainty. It finds that the latter substantially increases precautionary savings above and beyond the effect of ‘real’ income uncertainty. The effect of subjective economic uncertainty on behaviour has only begun to show up after the Great Recession. The economic crisis appears to have shifted households’ willingness to forgo current consumption for insurance purposes. Our results imply that households save above their optimal level especially after and during a crisis, potentially exacerbating the economic downturn.