Department of Economics

Evolution of Consumption Volatility for the Liquidity Constrained Households over 1983 to 2004

Evolution of Consumption Volatility for the Liquidity Constrained Households over 1983 to 2004

by Olga Gorbachev and Keshav Dogra

ABSTRACT

We study whether the increased income uncertainty in the US over the last quarter-century had a negative impact on household welfare by looking at variability of household consumption growth. We are particularly interested in understanding the effect of greater uncertainty on the liquidity constrained households. We study the evolution of liquidity constraints in the US in the Panel Study of Income Dynamics, extending Jappelli et al. [1998] methodology using information from the Survey of Consumer Finances. We find that although household indebtedness increased substantially, reflecting greater availability of credit, there was no decline in the proportion of liquidity constrained households between 1983 and 2007. Applying methodology developed in Gorbachev [2009], we find that the evolution of consumption volatility for the liquidity constrained households increased by economically and statistically more than for the unconstrained households. This increase was lower than that of family income volatility for these groups. Nevertheless, the welfare cost to society is substantial: we estimate that an average household would be willing to sacrifice 4.7 percent of nondurable consumption per year to lower consumption risk to its 1984 levels.

JEL Codes: D80, D91, E21, G29, I38

Keywords: panel data, Euler estimation, racial divide, uncertainty, credit

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