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A Model of Expenditure Shocks

We document four features of consumption and income microdata: (1) household-level consumption is as volatile as household income on average, (2) household-level consumption has a positive but small correlation with income, (3) many low-wealth households have marginal propensities to consume near zero, and (4) lagged high expenditure is associated with low contemporaneous spending propensities. Our interpretation is that household expenditure depends on time-varying consumption thresholds where marginal utility discontinuously increases. Our model with consumption thresholds matches the four facts better than does a standard model. Poor households in our model also exhibit “excess sensitivity” to anticipated income declines.

JEL classification codes: D14, E21.

Suggested citation: Miranda-Pinto, Jorge, Daniel Murphy, Kieran James Walsh, and Eric R. Young. 2020. “A Model of Expenditure Shocks.” Federal Reserve Bank of Cleveland, Working Paper No. 20-04.

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