Can Consumers Distinguish Persistent from Transitory Income Shocks?

CEBI Working Paper 03/18

61 Pages Posted: 15 Feb 2018

See all articles by Jeppe Druedahl

Jeppe Druedahl

University of Copenhagen - Department of Economics

Thomas Jørgensen

University of Copenhagen

Date Written: January 31, 2018

Abstract

We study whether households can distinguish persistent from transitory income shocks, and the implications for consumption-saving behavior. We construct a novel consumption-saving model where the household must infer the persistent component of its income process from actual income realizations together with an additional noisy private signal. We first show that the degree of imperfect information has important consequences for the interpretation of transmission parameters to persistent and transitory income shocks. A large transitory transmission parameter can e.g. be estimated despite of a low marginal propensity to consume because the short run covariance between income growth and consumption growth increases when households cannot distinguish persistent from transitory income shocks. We further show that the households’ degree of knowledge can be identified from panel data on income and consumption. Finally, we estimate a high degree of knowledge in the Panel Study of Income Dynamics.

Keywords: Consumption, Saving, Income Shocks, Learning, Consumer Information

JEL Classification: D11, D12, D15, D31, D83, E21

Suggested Citation

Druedahl, Jeppe and Jørgensen, Thomas, Can Consumers Distinguish Persistent from Transitory Income Shocks? (January 31, 2018). CEBI Working Paper 03/18, Available at SSRN: https://ssrn.com/abstract=3118090 or http://dx.doi.org/10.2139/ssrn.3118090

Jeppe Druedahl (Contact Author)

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark

Thomas Jørgensen

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

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