Excess Sensitivity Of Consumption Research Articles

Testing the presence of borrowing constraints from consumption responses to housing deposit changes

The literature on consumption recognizes the challenge of identifying the presence of borrowing constraints at the household level. In this study, we utilize a unique Korean housing contract, a chonsei contract, to characterize the consumption response to housing deposit changes when households are not limited by borrowing constraints. More specifically, we derive a lower bound for consumption changes, the violation of which indicates the presence of binding borrowing constraints. Applying the result to Korean household data, we identify a group of borrowing-constrained households and confirm the association between borrowing constraints and the excess sensitivity of consumption.

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.

Non-linear adjustments on the excess sensitivity of consumption with liquidity constraints

ABSTRACTThis article investigates the role of domestic credit markets in explaining the excess sensitivity of private consumption to disposable income using heterogeneous panel data of 19 OECD countries over the last two decades. We find that the degree of the excess sensitivity has decreased as the liquidity constraints of households have been alleviated: the estimated time-varying coefficients for the marginal propensity to consume vary between 0.16 for the countries with low liquidity constraints and 0.38 for those with high liquidity constraints. We also provide evidence that the excess sensitivity has been more prominent after the global financial crisis in some advanced countries, such as Japan, Spain, and the United States, where sharp deleveraging of households has been ongoing.

The permanent income hypothesis, transitional dynamics, and excess sensitivity of consumption

This paper studies the transitional dynamics of the linear-quadratic consumption model and reexamines existing analyses of the permanent income hypothesis (PIH). The model accounts for the life-cycle consumption behavior, with the short-run and long-run consumption functions linking consumption to wealth. We show that the random walk model of consumption violates the relevant stability condition and delivers predictions that are inconsistent with the PIH. We find that while excess sensitivity may be due to liquidity constraints, it can also arise in accordance with the PIH in perfect capital markets − contrary to the prevailing view. Simulation experiments prove useful to explain the observed consumption behavior.

New evidence on excess sensitivity of household consumption

The monthly salaries and allowances of Korean government employees are known in advance but vary greatly throughout the year. Using a Korean monthly panel data set, the present study examines how nondurable consumption expenditures in households headed by government employees respond to predictable income changes. The study finds a moderate excess sensitivity in consumption that can be attributed to about 9% of the households. Further analysis shows that these 9% of the households have lower ‘committed expenditures’ and are likely inattentive consumers.

Excess sensitivity of consumption

PurposeUntil now, traditional western consumption theories have not been able to adequately explain the consumption behavior of Chinese residents in the economic transitional period. Based on annual data from 1986 to 2004, the purpose of this paper is to examine the excess sensitivity of consumption through a variable parameter model.Design/methodology/approachA regression model was used to analyse annual consumption data from 1986 to 2004 in China.FindingsThe analysis demonstrates excess sensitivity characteristic in Chinese residents' consumption in the economic transitional period.Research limitations/implicationsThe paper concludes that in order to make the demand stimulation policy in China more effective, it is necessary to take a series of measures to correct the excess sensitivity of consumption, so as to establish a healthy cycle of national economy. The paper has only explained excess sensitivity of Chinese residents' consumption from the point of view of economics. While consumption is an economic problem as well as a social problem, those factors beyond economics should not be excluded from the analysis.Originality/valueThis paper differs from former studies in that previous scholars failed to take into consideration the special economic characteristics in China's transitional economy. The variable parameter model this paper employed takes full consideration of such unique factors as economic expectations and systems changes during the transitional period so as to better explain Chinese people's consumption behavior and provide a new perspective to make government policies stimulate domestic demand more effectively.

Reexamining the permanent income hypothesis with uncertainty in permanent and transitory innovation states

In this paper, we reexamine the permanent income–consumption relationship analytically and empirically, based on the innovation regime-switching (IRS) model developed in [Kuan, C.M., Huang, Y.L., Tsay, R.S., 2005. An unobserved component model with switching permanent and transitory innovations. Journal of Business and Economic Statistics, 23, 443–454]. A novel feature of the IRS model is that it explicitly allows for uncertainty in innovation states. When the labor income follows an IRS process, it is shown that the agent’s perception on the likelihoods of income innovations being permanent and transitory plays a crucial role in determining the optimal forecasts on the change of consumption. The effect of a current labor income innovation on consumption is a weighted average of two distinct effects resulting from permanent and transitory innovations with the weights equal to the perceived likelihoods of the respective states. Also, past innovations may affect consumption when there are revisions in the perceived likelihoods of previous states. Our empirical study on US data shows that consumption indeed reacts significantly to the perceived likelihoods of innovation states. However, even after controlling for the effect of state uncertainty, we find consumption vastly underreacts to permanent innovations in labor income but reacts about the right magnitude to transitory ones when compared with the prediction of the permanent income hypothesis. This evidence is similar to [Elwood, S.K., 1998. Testing for excess sensitivity in consumption: A state-space unobserved components approach. Journal of Money, Credit, and Banking, 30, 64–82] but in sharp contrast with that found in [Hall, R.E., Mishkin, F.S., 1982. The sensitivity of consumption to transitory income: Estimates from panel data on households. Econometrica, 50, 461–480].

Do liquidity constraints generate excess sensitivity in consumption? New evidence from a sample of post-bankruptcy households

Previous work linking liquidity constraints to excessive consumption sensitivity have used household level information on wealth and assets to split the sample into households that are likely to be constrained from those with access to credit and liquidity. In this paper, we use the sample splitting methods of previous authors but refine the criteria by using direct information on whether the household filed for bankruptcy in the last 10 years. Legally, a flag can appear on a bankruptcy filer’s credit report for up to 10 years after bankruptcy. This bankruptcy flag affects an individual’s credit score, and therefore the individual’s access to credit, which may make post-bankruptcy consumers liquidity constrained. Our results indicate that post-bankruptcy consumers exhibit excess sensitivity likely due to the bankruptcy flag. Consistency checks confirm that the source of sensitivity is due to liquidity constraints and not other observationally equivalent behavior.

Excess sensitivity of consumption, liquidity constraints, and mandatory saving

Using Singapore mandatory saving system, it is examined whether liquidity constraint is a major reason for the excess-sensitivity of consumption to predictable income growth. Although the mandatory saving rate for employees could be a good measure for the financial condition of a liquidity-constrained consumer, it is found, through the nonlinear instrumental variable estimation, that consumption growth is not sensitive to changes in the mandatory saving rate for employees. This finding suggests that liquidity constraints would not be a major reason for the excess-sensitivity puzzle.

Does Buffer-Stock Saving Explain the Smoothness and Excess Sensitivity of Consumption?

One of the lasting contributions to modernday consumer theory is the idea that consumption is determined by the expected value of lifetime resources, or permanent income. The modern-day specification of this concept is typically presented as a special case of intertemporalchoice theory, where felicity functions are quadratic, labor income is stochastic, there are no restrictions on borrowing, consumers have infinite horizons, and expectations are formed rationally. We refer to this model as the permanentincome hypothesis (PIH). Although the PIH has considerable intuitive appeal, a series of influential papers published after its inception revealed two notable discrepancies between the model's predictions and aggregate data. First, the model predicts that consumption growth should be more volatile than income growth if aggregate income growth has positive serial correlation (as the quarterly data suggest it does), yet aggregate consumption growth is in fact much smoother than aggregate income growth (Angus Deaton, 1987; John Y. Campbell and Deaton, 1989; Jordi Gali, 1991). Second, the PIH predicts that consumption changes should be orthogonal to predictable, or lagged, income changes, yet the coffelation between consumption growth and lagged income growth has been found to be one of the most robust features of aggregate data (for example, Marjorie A. Flavin, 1981; Alan S. Blinder and Deaton, 1985; Campbell and N. Gregory Mankiw, 1989; Orazio P. Attanasio and Guglielmo Weber, 1993). Thus aggregate consumption growth has been described as exhibiting two puzzles: it is both excessively smooth relative to current labor-income growth, and excessively sensitive to lagged labor-income growth. 2 In response to these and other empirical anomalies, researchers have recently sought out modifications of the PIH framework. Chief * Ludvigson: Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045; Michaelides: University of Cyprus, P.O. Box 20537, 1678 Nicosia, Cyprus. A previous version of this paper appeared under the title Can We Explain the Consumption Excesses Yet? Aggregate Consumption Implications of Buffer Stock Saving Behavior. For many helpful comments, we thank Orazio Attanasio, Dave Backus, Ben Bernanke, John Y. Campbell, Christopher Carroll, Todd Clark, Angus Deaton, PierreOlivier Gourinchas, Bo Honore, James Kahn, Martin Lettau, Costas Meghir, Christina Paxson, Steve Pischke, Andrew Samwick, Christopher Sims, Mark Watson, Guglielmo Weber, Michael Woodford, Steve Zeldes, and two anonymous referees, conference participants at the National Bureau of Economic Research Summer Workshop on the Aggregate Implications of Microeconomic Consumption Behavior, July 1998, the TMR Workshop on Saving and Pensions-CenTER, Tilburg University, March 1999, and the New York Area Macroeconomics Workshop, October 1998, seminar participants at Columbia University, INSEAD, the New York Federal Reserve, University College London, London Business School, City University Business School, University of Cyprus, Tel Aviv University, and Jeffrey Brown for excellent research assistance. The views expressed are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors. 1 Note that the important insight of Danny Quah (1990), that individuals may be better able than econometricians to distinguish short-run from long-run innovations to their income, cannot resolve the excess-smoothness puzzle laid out in Campbell and Deaton (1989). These authors show that-in the context of the PIH excess sensitivity and excess smoothness are the same phenomena. In addition, Campbell (1987) demonstrates that superior information of the type emphasized by Quah will show up in households' saving behavior, and using this information allows the econometrician to control for the agent's private information when predicting income. Since excess sensitivity is well established, and controlling for saving does not eliminate it (see Campbell and Deaton, 1989), the observed smoothness of consumption cannot be explained by superior information on the part of permanent-income consumers. See Deaton (1992) for further discussion. 2 Philippe Bacchetta and Stefan Gerlach (1997) and Ludvigson (1999) document another kind of excess sensitivity: the correlation between consumption growth and predictable changes in consumer credit. Although we do not explore these findings here, Ludvigson finds that a bufferstock model with time-varying liquidity constraints can replicate such a correlation.

Consumption Smoothing and Financial Integration in the European Union

In this paper we explore the likely implications of financial integration for intertemporal consumption smoothing in member countries. We uncover an intriguing pattern of excess sensitivity of consumption to current income in EU countries prior to integration using two procedures which handle most known time series estimation problems. We then relate this pattern to characteristics of banking sectors, using nonparametric tests which control for several such characteristics, and discuss likely implications of removing impediments to entry of foreign banks. Although conclusions about convergence following financial integration are less optimistic than previously thought, they also point to the need for broad financial integration.

Direct tests of the permanent income hypothesis under uncertainty, inflationary expectations and liquidity constraints

Several studies have argued that the life-cycle permanent income hypothesis (LC-PIH) of Hall (1978) breaks down because of the excess sensitivity of consumption to current income and through consumers failing to exploit information which is available in period t-1. Using direct expectations data based on consumer surveys for the U.S., this study shows that when uncertainty, in particular, and credit constraints are accommodated in the model, consumption is not sensitive to current income. Moreover, contrary to previous empirical findings, the index of consumer confidence is found to be unable to predict consumption. Thus, the theoretical predictions of the rational expectations LC-PIH are unfounded empirically because they fail to accommodate uncertainty, in particular, and credit constraints.

Can Buffer Stock Saving Explain the Smoothness and Excess Sensitivity of Consumption?

The buffer-stock model of precautionary saving has become a workhorse of modern-day consumer theory. Despite its growing popularity, virtually no research has set out to formally investigate whether buffer-stock behavior can replicate the well-known smoothness of aggregate consumption growth (excess smoothness), or its correlation with lagged income (excess sensitivity). We investigate an aggregate version of the standard buffer stock model and examine how its predictions vary according to whether individuals observe economy-wide variation in their income. Our results show that, when individuals observe each component of their income, aggregate buffer stock consumption growth is at least as volatile as aggregate income growth and insignificantly correlated with lagged income growth. We show that adding incomplete information about aggregate income goes part of the way toward resolving these discrepancies, but still falls short of matching the data in magnitude. In particular, buffer stock saving creates a smoothness puzzle for aggregate consumption that remains to be explained.

Testing for Excess Sensitivity in Consumption: A State-Space/Unobserved Components Approach

This paper tests the joint rational expectations/permanent income hypothesis using a state-space/unobserved components model to specify anticipated and unanticipated elements of permanent, transitory, and seasonal components of the income path and measure their relationships with consumption. The results do not find significant excess sensitivity. However, a similar test that accounts for seasonality using X-11 adjusted data does, thus indicating that seasonal filtering may be responsible for previous empirical rejections of the theory. Since the model includes consumption information in estimating the different components of income, it also improves upon univariate investigations of the relative magnitudes of permanent and transitory disturbances to the income path.

How forecastable is consumption growth? New evidence on the Hall random walk hypothesis

I provide new evidence on the accuracy of the Hall random walk hypothesis that consumption growth is not predictable. Using 1971–94 US data, I find that consumption growth is substantially more predictable than previously believed. A regression of consumption growth on lagged nominal interest rate changes, lagged consumption growth and forecasts by Data Resources, Inc. yields an adjusted R-squared of 0.32. The empirical tests further suggest that excess sensitivity of consumption to current disposable income, rather than time-varying real interest rates or non-separable utility, is the most likely explanation for the predictability of consumption growth.

Precautionary Saving: An Explanation for Excess Sensitivity of Consumption

The permanent income hypothesis under certainty equivalence yields a martingale consumption process. Empirically, this hypothesis is rejected because consumption is excessively sensitive to anticipated income. One approach to account for excess sensitivity is to relax certainty equivalence by using utility functions that induce precautionary saving. This article analyzes a hyperbolic absolute risk-aversion utility function. Empirically, some reasonable parameterizations of this specification allow one to match the excess sensitivity associated with the data. These parameterizations also permit one to account for the excess smoothness problem. Excess sensitivity and excess smoothness, however, do not reflect the same phenomenon.