Effects of Income Shocks on Consumer Behavior: A Panel Event Study Testing the Permanent Income Hypothesis in Household Economic Dynamics

Abstract

This study examines the effect of anticipatory and unexpected discrete labor income shocks on household consumption. By implementing a panel event study, we can allow for the staggered timing of intervention (e.g., voluntary or involuntary job loss). This allows us to test for causal effects of income shocks on consumption alongside their dynamic, persisting, or transitory effects. Drawing on data from the Panel Study of Income Dynamics, the longest U.S. longitudinal panel survey of American families' household dynamics, we can identify plausibly exogenous income shocks and heterogeneous household post-treatment effects to test the applicability of the Permanent Income Hypothesis (PIH). The dynamic regression results in statistically significant declines in household consumption following an unexpected shock to income, particularly in the case of a persistent decline in labor income. There are no effects on consumption when a voluntary job loss, such as when quitting occurs, which aligns with PIC but may be due to unobserved heterogeneous factors and negative income shock distribution skewness.