How does future income affect current consumption?

Abstract

This paper tests a straightforward implication of the basic Life Cycle model of consumption: That current consumption depends on expected lifetime income. The paper projects future income for a panel of households and finds that consumption is closely related to projected current income, but unrelated to predictable changes in income. However, future income uncertainty has an important effect: Consumers facing greater income uncertainty consume less. The results are consistent with ‘buffer-stock’ models of consumption like those of Deaton [1991] or Carroll [1992a, 1992b], where precautionary motives greatly reduce the willingness of prudent consumers to consume out of uncertain future income. © 1994 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.