American Economic Journal: Macroeconomics April 2022: https://www.aeaweb.org/articles?id=10.1257/mac.20190296
Abstract: Studies based on natural experiments find that consumption responds strongly and significantly to a transitory variation in income, while semistructural estimations find no pass-through of transitory shocks to consumption. I develop a more robust semistructural estimator that relaxes the assumption that log consumption is a random walk. The robust pass-through estimate is significant and large, implying a yearly marginal propensity to consume of 0.32, close to the natural experiment findings. The robust estimator performs well in numerical simulations of a life cycle model, while nonrobust estimators do not. The difference between the two in the simulations is similar to their difference in the survey data.
with Richard Blundell, Margherita Borella & Mariacristina De Nardi
American Economic Review February 2024: https://www.aeaweb.org/articles?id=10.1257/aer.20220555
Abstract: In the United States, after age 65, households face income and health risks, and a large fraction of these risks are transitory. While consumption significantly responds to transitory income shocks, out-of-pocket medical expenses do not. In contrast, both consumption and out-of-pocket medical expenses respond to transitory health shocks. Thus, most US elderly keep their out-of-pocket medical expenses close to a satiation point that varies with health. Consumption responds to health shocks mostly because adverse health shocks reduce the marginal utility of consumption. The effect of health on marginal utility changes the optimal transfers due to health shocks.
Abstract: The marginal propensity to consume (MPC) is a central object in economics that is key to understand the transmission of shocks. Recent empirical findings challenge the standard view that its distribution is mostly explained by constraints on liquid wealth: (i) some people with substantial liquid wealth have a high MPC; (ii) higher current earnings, which should relax the constraints, do not reduce the MPC. I note that, in the standard consumption model, it is the combination of people’s liquid wealth and the variance of their future earnings that determines their precautionary motive and constraints, thus their MPC. Everything else being equal, a higher permanent component of earnings, means a higher variance of future earnings and a higher MPC. This can explain (i)-(ii). Survey data support a large and positive effect of permanent earnings on the MPC. Numerical simulations can replicate those findings quantitatively in a model with realistic earnings risk.
Abstract: While macro models increasingly incorporate substantial risk, the theoretical knowledge about the effect of uncertainty on consumption growth consists of intuitions from the second order log-linearized Euler equation. I show that the derivation of the log-linearized Euler equation is flawed in that it does not consist in linearizing an Euler equation but in linearizing an ad-hoc mathematical identity. I prove exactly that uncertainty raises consumption growth and makes consumption depart from a random walk. I also prove that this precautionary consumption growth is decreasing in assets, and in transitory and permanent income when income is a transitory-permanent process.
Abstract: I prove analytically that, in the standard life-cycle model used throughout the macroe- conomic literature, consumption is not linear but concave in the permanent income component of a standard transitory-income process. The reason for the concavity in income is the opposite of that behind the seminal result of concavity in (accumulated) wealth, established in Carroll and Kimball (1996). An increase in permanent income strengthens the need for precautionary saving, and more so at a high level of permanent income: consumption responds less to an increase in permanent income at high levels because the need for saving increases more. In contrast, an increase in wealth reduces the need for precautionary saving, but less so at a high level of wealth: consumption also responds less to an increase in wealth at a high level of wealth but now because the need for saving decreases less. I also find empirical evidence suggesting that the results holds in US survey data.