The response of expenditures to anticipated income changes: panel data estimates

Standard models of intertemporal allocation predict that the time path of expenditures should be independent of the time path of income. Recently two papers, Parker (1999) and Souleles (1999) have suggested that U.S. households have a high marginal propensity to spend within year anticipated income changes. We use an expenditure survey panel from Spain to re-examine this issue. We exploit two important features of the Spanish data. First, we have quarterly panel data that follows households for more than four quarters. Second, we use the fact that workers are exogenously sorted into one of two payment schemes: some receive the same amount each month of the year and others receive an extra payment in June and December. The extra payment is large and predictable. We examine the detailed pattern of expenditures over the year to see whether they differ between the two groups. We fail to find even weak differences. We complement this with a conventional Euler equation analysis of excess sensitivity. Our predicting equation for (quarterly) earnings growth is much better than usual and is likely to give a powerful test of the hypothesis that predictable changes in income do not lead to changes in expenditure patterns. The results of this analysis confirm the graphical analysis: we find no evidence of excess sensitivity. We conclude that households in normal times do smooth consumption over the year. We suggest a reconciliation of our results with those of Parker and Souleles