Disentangling Insurance and Information in Intertemporal Consumption Choices

The textbook version of the life-cycle permanent income hypothesis with no liquidity constraints predicts that consumption should react very mildly to (unanticipated) transitory income changes and very strongly to permanent ones. This prediction has important policy implications in understanding the response of consumers to tax rebates or increases that are made for stabilization purposes. In recent years there has been a resurgence of interest in estimating these important parameters, either using quasiexperimental data (such as randomization of the timing when tax rebate checks are received by households; see David Johnson, Jonathan Parker, and Nicholas Souleles 2006), or imposing structural restrictions on the stochastic income process faced by consumers (Orazio Attanasio and Nicola Pavoni 2008; Richard Blundell, Luigi Pistaferri, and Ian Preston 2008; Jonathan Heathcote, Kjetil Storesletten, and Giovanni L. Violante 2007; Giorgio Primiceri and Thijs van Rens, forthcoming). The main objection of quasi-experimental studies is that the results may be context-specific. The main problem with the second strand of the literature is that estimates of the response of consumption to income shocks may confound two issues, insurance and information. On the one hand, the estimate reflects the ability (or lack thereof) of the household to smooth consumption through a variety of channels, such as self-insurance, government-provided insurance, credit markets, or other informal mechanisms. On the other hand, the identification strategy requires the ability to statistically separate what is a shock from what is an anticipated event (when seen from the point of Disentangling Insurance and Information in Intertemporal Consumption Choices