Can Consumers Distinguish Persistent from Transitory Income Shocks?

Jeppe Druedahl*, Thomas Høgholm Jørgensen

*Corresponding author for this work

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

The degree to which consumers can distinguish persistent from transitory income shocks is paramount for consumption-saving dynamics. In particular, even a small amount of imperfect information causes a severe bias in conventional estimators of the marginal propensity to consume. We provide a novel method that can identify consumers’ degree of information by using panel data on income and consumption, even allowing for measurement error. Employing our method to data from the Panel Study of Income Dynamics, we find that households have almost perfect information. This robust result indicates that the conventional estimators of the marginal propensity to consume are on firm ground.
Original languageEnglish
JournalThe Economic Journal
Volume130
Issue number632
Pages (from-to)2410–2437
ISSN0013-0133
DOIs
Publication statusPublished - Nov 2020

Cite this