Evidence on excess sensitivity of consumption to predictable income growth

This paper tests for excess sensitivity of consumption to predicted income growth using a behavioral model that allows for myopia and/or irrationality. We use a micro dataset containing subjective expectations about future income and subjective indicators of the families’ financial condition that make us possible to evaluate the response to income changes of agents with liquidity constraint problems. We do not find significant evidence of excess sensitivity of consumption to income, as well as in the case in which we take into account liquidity constraints. Moreover, we find that agent’s systematic errors are statistically significant in explaining consumption changes for all specifications considered.