Income Changes and Consumption: Evidence from the 2013 Federal Government Shutdown

Review of Economic Dynamics, 23(1), 99-124, January 2017
Coauthor: Scott Baker

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We use the 2013 federal government shutdown and a rich data set from an online personal finance website to study the effects of changes in income on changes in consumption. The 2013 shutdown was a significant and unanticipated income shock for federal government workers, with no direct effect on permanent income. We exploit both the differences between unaffected state employees and affected federal employees as well as between federal employees required to remain at work and those required to stay at home to generate variation in income and leisure time. We find strong evidence for excess sensitivity of consumption patterns, violating the permanent income hypothesis. The decline in spending can be largely explained by increased home production, changes in spending allocations, and credit constraints. We are able to discern detailed categories of household spending with widely varying elasticities. The results demonstrate the importance of household liquidity, leisure and home production when constructing stimulus or social insurance policy.