The Pattern of Consumption Changes to Permanent Income Shocks: Japan-US Comparison

Abstract

The purpose of this paper is to investigate what kind of consumption model is supported using hypothetical questions which asked about the pattern of consumption changes to permanent income shocks. According to the life cycle/permanent income hypothesis (LCPIH), if people face a permanent income shock, they would change their consumption immediately. However, the proportion of respondents choosing the choice pattern which is consistent with LCPIH is only 1.6% in Japan and 3.9% in United States. The results of the hypothetical question show a variety of patterns of consumption changes to permanent income shocks. In both Japan and the U.S., many households do not change their consumption immediately even if their permanent income increases. This behavior could be explained by the asset preference model. Moreover, there are many households who choose a consumption path that is consistent with the habit formation model. Furthermore, we show that the prediction of borrowing constraint model is consistent with the choice of households who face the borrowing constraint in reality.