Permanent versus Transitory Income Shocks over the Business Cycle

Abstract

This paper investigates the role of subjective income expectations in shaping consumption dynamics of European economies in the last decade. We make two main contributions. We first exploit the joint availability of income expectations and realizations in a unique micro panel-dataset to identify the levels of transitory and permanent income shocks at the individual level. We then evaluate whether these calculated income shocks can help to explain contractions in aggregate consumption over the two most recent crisis. We find strong evidence that consumption behavior during the 2012-2013 crisis can be explained by the observed income shocks, but the same is not true of the 2008-2009 crisis.