In this paper we analyze causes for the empirical puzzle that people respond less to very persistent income shocks than predicted by the theory (“excess smoothness of consumption”). Using Italian data on people’s earnings expectations, they show that superior information of the individual compared to the researcher can explain this finding, for example people anticipate positive income shocks due to promotions and adjust their consumption accordingly, while they disprove the potential explanation of insurance of permanent shocks for the Italian case. Understanding how people respond to transitory and permanent income shocks and to what degree they can insure themselves against these shocks has important policy implications, for example to evaluate the effect of tax cuts to stimulate the economy.
Disentangling Insurance and Information in Intertemporal Consumption Choices
KAUFMANN, KATJA MARIA;
2009
Abstract
In this paper we analyze causes for the empirical puzzle that people respond less to very persistent income shocks than predicted by the theory (“excess smoothness of consumption”). Using Italian data on people’s earnings expectations, they show that superior information of the individual compared to the researcher can explain this finding, for example people anticipate positive income shocks due to promotions and adjust their consumption accordingly, while they disprove the potential explanation of insurance of permanent shocks for the Italian case. Understanding how people respond to transitory and permanent income shocks and to what degree they can insure themselves against these shocks has important policy implications, for example to evaluate the effect of tax cuts to stimulate the economy.
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