Income Shocks and their Transmission into Consumption

TL;DR

This paper reviews recent economic research on how income shocks affect household consumption, highlighting three main methodological approaches used to estimate this relationship.

Contribution

It provides a comprehensive overview of the last 20 years of literature, categorizing methods into structural models, natural experiments, and surveys.

Findings

Structural models reveal detailed consumption responses.

Natural experiments compare affected and unaffected groups.

Surveys gather consumer expectations about income shocks.

Abstract

This article reviews the economics literature of, primarily, the last 20 years, that studies the link between income shocks and consumption fluctuations at the household level. We identify three broad approaches through which researchers estimate the consumption response to income shocks: 1.) structural methods in which a fully or partially specified model helps identify the consumption response to income shocks from the data; 2.) natural experiments in which the consumption response of one group who receives an income shock is compared to another group who does not; 3.) elicitation surveys in which consumers are asked how they expect to react to various hypothetical events.