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Permanent versus Transitory Income Shocks over the Business Cycle

Agnes Kovacs, Concetta Rondinelli and Serena Trucchi
IFS Working Paper WP19/29

This paper investigates how different income shocks shape consumption dynamics over the business cycle. First, we break new ground by creating a unique, panel dataset of transitory and permanent income shocks, using subjective income expectations from the Dutch Household Survey. Second, we evaluate whether these observed income shocks help to explain contractions in aggregate consumption over the two most recent crises. We find that the income shocks experienced during the 2008-2009 Global Financial Crisis are of a different nature than the shocks experienced during the 2011-2012 Sovereign Debt Crisis, with the 2011-2012 shocks being perceived as more permanent. This helps explain why consumption falls less during the Global Financial Crisis, despite the fact that income declines more than during the Sovereign Debt Crisis.

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IFS Working Paper WP19/24
I characterize how house price shocks affect consumption inequality using a life-cycle model of housing and non-housing consumption with incomplete markets.