CONSUMPTION SENSITIVITIES IN ESTONIA: INCOME SHOCKS OF DIFFERENT PERSISTENCE Merike Kukk, Dmitry Kulikov, Karsten Staehr   Working Papers of Eesti Pank No 3/2012

The Permanent Income Hypothesis (PIH) entails that consumption reacts more strongly to persistent than to temporary income shocks. This prediction is tested using data from the Estonian Household Budget Surveys for 2002-2007. The dataset contains questions which make it possible to distinguish between persistent and temporary income shocks based on the households' own assessment. The estimations confirm that the marginal propensities to consume out of the two income shocks differ, households are forward-looking and seek to smooth consumption. Moreover, the estimated propensities of persistent shocks are of reasonable magnitudes, consistent with the PIH. Further analysis reveals, however, features that are in breach of the PIH. The consumption estimations are affected by lagged temporary income shocks. When income shocks are decomposed into positive and negative values, there is evidence of excess sensitivity to positive temporary shocks.
JEL Code: D12, E21, R22
Keywords: consumption, Permanent Income Hypothesis, income persistence, consumption smoothing, rule-of-thumb consumption

Author's e-mail address: karsten.staehr@eestipank.ee, karsten.staehr@tseba.ttu.ee

The views expressed are those of the authors and do not necessarily represent the official views of Eesti Pank.

Contents

1. Introduction

2. Consumption response to income shocks: a brief literature overview

3. Theoretical framework

4. Dataset and identification of income shocks

4.1. The Estonian Household Budget Survey

4.2. Identification of income shocks in the Estonian HBS

5. Consumption estimations

5.1 PIH estimations

5.2 Sensitivity to lagged temporary income shock

5.3 The rule-of-thumb consumption among Estonian households

5.4 Consumption response to positive and negative income shocks

6. Final comments

References

Appendix A: Variable definitions

Appendix B: Identification of income shocks in the Estonian HBS

Appendix C: Robustness checks of income persistence estimations

Appendix D: Robustness checks of PIH model

Consumption Sensitivities in Estonia: Income Shocks of Different Persistence , Working Papers of Eesti Pank No 3/2012 (PDF)