The Hidden Interaction: Household Consumption and Advance Information about Future Income

Abstract

This paper studies how advance information about future labour income affects current household consumption. Using data from the Panel Study of Income Dynamics, I find that working households adjust their current consumption in anticipation of future persistent income changes, indicating households’ undocumented access to advance information. I construct a partial equilibrium, consumption-saving model to map observed consumption response patterns into the unobserved probability of receiving advance information by households with different level of persistent income. My findings suggest that first, households with access to advance information are better self-insured against persistent income shocks compared to those without such information. Second, informed households’ consumption responses to persistent shocks are dynamic, with around 70% of the total adjustment occurring in the period when the in- formation is first received. Lastly, I show that accounting for short-term foresight significantly alter our established understanding of consumption insurance and the welfare consequence of existing government-funded income assistance programs. The combination of nonlinear panel method and structural modelling can uncover hidden behavioural mechanisms that are otherwise unobservable.

Link to Paper

Access latest draft here.