Characterizing income shocks and their transmission to household consumption

In this chapter we use household income and consumption data to establish whether income shocks are temporary or permanent, and to what extent they translate into changes in consumption. To this end we use income micro-data from six European countries that differ in a number of respects, including their welfare systems, but also income and consumption panel data from Italy, Spain, and Denmark. We find that in some countries temporary shocks are reasonably well insured, but in all countries we consider permanent shocks are (to a large extent) not. We argue that this explains why we find it takes so long to recover from a financial hardship episode, and its effects take so many years to wear out.