Paulo Lins from Clemson University will present "Consumption’s Response to Permanent Income: The Role of Consumption Commitments"

Abstract: The textbook permanent-income hypothesis predicts that the level of consumption is proportional to the level of permanent income, while, in the data, the elasticity of consumption to permanent income appears to be far below one. In this paper, I provide evidence for a novel theory for this consumption under-response to permanent income based on consumption commitments – hard-to-adjust consumption choices that resemble long-term commitments. Empirically, I document four main new facts that support the theory: (a) the consumption elasticity to permanent income is larger for younger households, (b) it depends on past income trajectories, and (c) it becomes larger after households adjust their commitments; furthermore, I show that (d) those households that have “under-responded” to their income growth skew spending away from hard-to-adjust goods (notably shelter). These facts are evidence in favor of household “lock-in” to past consumption choices. Quantitatively, I show that consumption commitments are necessary for life-cycle models to account for all the documented facts.