Scarred Consumption

Abstract

We show that prior lifetime experiences can "scar" consumers. Consumers who have lived through times of high unemployment exhibit persistent pessimism about their future financial situation and spend significantly less, controlling for the standard life-cycle consumption factors, even though their actual future income is uncorrelated with past experiences. Due to their experience-induced frugality, scarred consumers build up more wealth. We use a stochastic lifecycle model to show that the negative relationship between past experiences and consumption cannot be generated by financial constraints, income scarring, and unemployment scarring, but is consistent with experience-based learning.