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.