INTERTEMPORALCHOICEANDCONSUMPTIONMOBILITY.pdfVIP

INTERTEMPORAL CHOICE AND CONSUMPTION MOBILITY Tullio Jappelli Luigi Pistaferri University of Salerno CSEF, and CEPR Stanford University, CEPR, and SIEPR Abstract The theory of intertemporal consumption choice makes sharp predictions about the evolution of the entire distribution of household consumption, not just about its conditional mean. In the paper, we study the empirical transition matrix of consumption using a panel drawn from the Bank of Italy Survey of Household Income and Wealth. We estimate the parameters that minimize the distance between the empirical and the theoretical transition matrix of the con- sumption distribution. The transition matrix generated by our estimates matches remarkably well the empirical matrix, both in the aggregate and in samples stratified by education. Our estimates strongly reject the consumption insurance model and suggest that households smooth income shocks to a lesser extent than implied by the permanent income hypothesis. (JEL: D52, D91, I30) 1. Introduction How much consumption responds to income shocks is a central question in macroeconomics. As is well known, this response depends on the particular model that characterizes consumption behavior. For instance, the permanent income hypothesis (PIH) implies that households set consumption equal to permanent income, smoothing out transitory income fluctuations, but responding one-to-one to permanent shocks. On the other hand, under perfect insurance markets the distribution of marginal utilities is constant over time, and consumption does not respond to idiosyncratic income shocks. Deaton and Paxson (1994) have stud- ied the implications of these theories for the dynamics of consumption inequality. They show that under the PIH or other models with incomplete markets, consump- tion inequality within a group of households with fixed membership should, on Acknowledgments: Thanks a