Anticipated Income Changes Research Articles

Consumption Response to Anticipated Income Changes: Evidence from the Magnitude Effect

Consumption Response to Anticipated Income Changes: Evidence from the Magnitude Effect

Household heterogeneity and consumption dynamics in the presence of borrowing and liquidity constraints

ABSTRACTI study the effects of borrowing and liquidity constraints on the response of consumption to anticipated income changes. Using the PSID over 1999–2013, I find that the well-documented strong excess sensitivity of consumption to income of highly constrained households can be explained by episodes of income increases. In addition, I look into the heterogeneity of households without debt, a group that has been largely disregarded by the literature. My fixed-effects estimates show that only those without debt tend to increase their saving in response to anticipated income declines, irrespective of the amount of liquid assets held.

Do households smooth expenditure over anticipated income changes? Evidence from bonus payments to public employees in Japan

This paper provides new evidence of consumers’ reaction to an anticipated sizable change in income. Until FY2002, Japanese public employees received predictable large bonus payments three times a fiscal year (in June, December, and March), but the March bonus was abolished in FY2003. We compare the seasonal patterns of public employees’ expenditure before and after the reform of the bonus payment schedule. Contrary to the prediction of the life cycle/permanent income hypothesis (LC/PIH), we find evidence that monthly patterns of household expenditure were significantly affected by the anticipated large change in income pattern. However, at closer inspection, this excess sensitivity of expenditure is observed only for expenditure subcategories of some durability, i.e., durables and semi-durables. Thus, while the LC/PIH does not appear to hold for expenditure (which we observe here), it may still hold for consumption.

Liquidity Constraints and the Permanent Income Hypothesis: Pseudo Panel Estimation with German Consumption Survey Data

This paper empirically investigates the relevance of liquidity constraints and excess sensitivity in intertemporal household consumption. Using a pseudo panel that has been constructed on rich German consumption survey data, we estimate the consumption responses to permanent and transitory income shocks, as well as the presence of excess sensitivity to anticipated income changes. A switching regression approach with unknown sample separation is applied to identify the two regimes whether to be liquidity constrained or not. The results are used to test whether liquidity constraints affect the validity of the permanent income hypothesis. For households in the constrained regime, reactions to changes in transitory income are found to be significantly greater than for households in the unconstrained regime. Furthermore, we provide evidence for excess sensitivity to anticipated income changes for households in the constrained regime if total consumption, durable as well as non-durable, is considered.

The Response of Household Expenditure to Anticipated Income Changes: Bonus Payments and the Seasonality of Consumption in Japan

This paper exploits a notable institutional feature of salary payments in Japan, the bonus system, to examine whether households smooth consumption under large and regular income changes. Using high quality household-level data from the Japanese Family Income and Expenditure Survey (FIES), our statistical tests show that the consumption seasonality of bonus receiving households is significantly affected by the bonus payments. Although our estimate of the marginal propensity to consume from bonus income is much smaller than that from smaller and less predictable end-of-year tax refunds, it is positive and significantly different from zero, which contrasts to earlier studies on large and regular income changes.

Transaction Costs and Consumption

The Rational Expectations Permanent Income Hypothesis (RE-PIH) fails to explain several features of consumption behavior documented by previous researchers. First, the marginal propensity to consume (MPC) out of unanticipated income shocks tends to decrease as the size of the shocks becomes larger. Second, the MPC out of small income shocks is well above what the RE-PIH predicts. Third, consumption responds to small anticipated income changes, but not to large ones. This paper argues that these findings can be reconciled within a RE-PIH framework that includes a cash-in-advance constraint. In the model, the representative agent is assumed to be fully rational with perfect information and is able to borrow against future income. The agent can hold cash and interest-bearing assets, but has to pay a fixed transaction cost to transfer wealth between cash and assets. I show that the agent follows an s-S rule with respect to cash holdings in making wealth-transfer decisions. The MPC within the no-transfer band is higher than that out of the band. It can be lower than or exactly equal to 1. The model also predicts that agents smooth consumption in response to news of large future income changes but not to small ones. Furthermore the model sheds light on the demand for liquid assets and the equity premium puzzle.

Do Consumers React to Anticipated Income Changes? Evidence from the Alaska Permanent Fund

A central implication of the life-cycle/permanentincome hypothesis (LC/PIH) is that consumers should not respond to predictable changes in their income. To test this hypothesis, a number of recent papers have exploited natural experiments to identify anticipated income changes. In particular, recent work by Parker (1999) uses the change in after-tax income due to the cap on earnings subject to the Social Security tax, and a related paper by Souleles (1999) examines the response of consumption to income tax refunds. Surprisingly, Parker and Souleles find that even when income is expected to change within the year, expenditure is excessively sensitive to the timing of the income change. While their results can be interpreted as evidence that our canonical model of consumption is inadequate, an alternative explanation is that the anticipated income changes they exploit are small and irregular, and that households will not bother to change their consumption paths when the computational costs involved are large relative to the utility gains. In support of this interpretation, Browning and Collado (2001) find that the seasonal consumption patterns of Spanish households that work in sectors that provide regular bonus payments do not differ from those of households that do not receive bonus payments. This paper adds to this evidence by exploiting a natural experiment provided by annual payments from the state of Alaska’s Permanent Fund to every resident in the state of Alaska that should yield an unusually powerful test of the LC/PIH. These payments are large and clearly anticipated by Alaskan residents. Using the variation in the size of the payments over time and in the amount received by families of different sizes to identify the response of consumption to payments from the Permanent Fund, I find no evidence that the consumption of Alaskan households reacts to these payments. In addition, I find no evidence that the seasonal pattern of consumption in Alaska differs from that in the other 49 states or that households in Alaska are subject to fewer liquidity constraints, engage in less buffer-stock saving, or spend a smaller fraction of their income on semidurable goods than households in the rest of the United States. However, although households in Alaska do not overreact to payments from the Permanent Fund, I find that the consumption of the very same households is excessively sensitive to their income tax refunds. This evidence suggest that households will take anticipated income changes into account in their consumption decisions when the income changes are large, regular, and easy to predict, but will not do so when they are small and irregular. The paper proceeds as follows. The next section of the paper presents details on the * Department of Economics, Princeton University, Princeton, NJ 08544, and National Bureau of Economic Research (e-mail: chsieh@princeton.edu). I am very grateful to the Bureau of Labor Statistics (BLS) for providing access to the data from the Consumer Expenditure Survey and to its staff, particularly Steven Henderson, Walter VandeHeide, and Wolf Weber, for their generous assistance during my visits to the BLS. I also thank Nanci Jones for providing data and patiently answering questions on the operation of the Alaska Permanent Fund. Anne Case, Angus Deaton, Jonathan Parker, and two referees provided useful comments. The views expressed in this paper are personal and should not be attributed to the BLS. 1 I refer to the certainty-equivalent version of the LC/ PIH, or one in which the expected variance of consumption is constant. As is well known, without these assumptions, the LC/PIH only implies smoothing of marginal utility, not necessarily of consumption. 2 See Christina H. Paxson (1992); John Shea (1995); Jonathan A. Parker (1999); Nicholas S. Souleles (1999); Martin Browning and M. Dolores Collado (2001). Also see Ronald A. Bodkin (1959) for an early example of the use of a natural experiment to test for excess sensitivity. For comprehensive reviews of the large literature on empirical tests of the LC/PIH, see Angus Deaton (1992), Browning and Annamaria Lusardi (1996), and Browning and Thomas F. Crossley (2001). 3 In 1998, for example, the Permanent Fund paid $1,541 to every resident of the state of Alaska.

The Response of Expenditures to Anticipated Income Changes: Panel Data Estimates

Standard models of intertemporal allocation predict that the time path of expenditures should be independent of the time path of income. Recently two papers, Parker (1999) and Souleles (1999) have suggested that U.S. households have a high marginal propensity to spend within year anticipated income changes. We use an expenditure survey panel from Spain to re-examine this issue. We exploit two important features of the Spanish data. First, we have quarterly panel data that follows households for more than four quarters. Second, we use the fact that workers are exogenously sorted into one of two payment schemes: some receive the same amount each month of the year and others receive an extra payment in June and December. The extra payment is large and predictable. We examine the detailed pattern of expenditures over the year to see whether they differ between the two groups. We fail to find even weak differences. We complement this with a conventional Euler equation analysis of excess sensitivity. Our predicting equation for (quarterly) earnings growth is much better than usual and is likely to give a powerful test of the hypothesis that predictable changes in income do not lead to changes in expenditure patterns. The results of this analysis confirm the graphical analysis: we find no evidence of excess sensitivity. We conclude that households in normal times do smooth consumption over the year. We suggest a reconciliation of our results with those of Parker and Souleles.