The consumption response to income changes

We review different empirical approaches that researchers have taken to estimate how consumption responds to income changes. We critically evaluate the empirical evidence on the sensitivity of consumption to predicted income changes, distinguishing between the traditionalexcess sensitivity tests, and the effect of predicted income increases and income declines. We also review studies that attempt to estimate the marginal propensity to consume out of income shocks, distinguishing between three different approaches: identifying episodes in which income changes unexpectedly, relying on the covariance restrictions that the theory imposes on the jointbehavior of consumption and income growth, and combining realizations and expectations of income or consumption in surveys where data on subjective expectations are available.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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