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CONSCRISIS Report Summary

Project ID: 655770
Funded under: H2020-EU.1.3.2.

Periodic Reporting for period 1 - CONSCRISIS (Households’ Consumption during the Great Recession: A structural analysis on the role of expectations)

Reporting period: 2015-11-01 to 2017-10-31

Summary of the context and overall objectives of the project

Over the last ten years, several European countries have experienced two main episodes of slowdown in aggregate consumption. We observe a first contraction in aggregate consumption around 2008-2009, and a second one in 2011-2012. The goal of the main work, which I carried out within the CONSCRISIS project, is to investigate the role of income expectations in driving the contraction in household consumption observed during the two episodes. For this purpose, the work illustrates how the perceived degree of persistence in the income shock evolved over the recent crisis, and to which extent the shocks were different between the initial and the second phase. Moreover, it measures individual uncertainty about future income, which may strengthen the precautionary motive for savings. It also analyzes how perceptions about the persistence of income shocks and income uncertainty reflect into households' consumption expenditure.
Along with this core issue, I illustrate the impact of wealth shocks on consumption and labour supply during the Great Recession. I also examined household consumption, wealth accumulation and labour supply from different perspectives.
Given the topical subject, investigating the determinants of the economic crisis contributes to the scientific literature on households’ consumption and saving choices, and informs the economic and policy debate in Europe. This study provides policymakers with a useful tool to understand households’ choices and, thus, implement effective interventions in sustaining consumption and hampering the recession.

Work performed from the beginning of the project to the end of the period covered by the report and main results achieved so far

To address the research questions, the empirical analysis focuses on the Dutch case. It relies on a unique panel micro-dataset, collected by CentERdata on behalf of Dutch National Bank (DNB), which gathers information about expectations on future income, along with its realization. This unique source of information allows to identify the transitory and permanent component of the income shock and individual uncertainty about future resources.
The main findings show a change in the perception of the persistence of income shocks between the two phases of the recession. Between 2008-09, the negative shock is perceived to be transitory, while in the second economic downfall (2012-13), respondents revise downward their expectations about permanent income shocks. Permanent shocks in the second phase of the recession are perceived to be larger by younger cohorts. Finally, we observe an increase in the variance of expected income shocks since 2011. I find a response of consumption to permanent and transitory income shocks.
During the Marie Skłodowska-Curie fellowship, I also contributed to the investigation of household behaviour during the Great Recession by analysing the impact of wealth shocks on consumption and labor supply.
Results from my research show that one euro fall in risky financial wealth resulted in cuts in annual total (non-durable) consumption of 8.5-9 (5.5-5.7) cents. Counterfactuals indicate financial-wealth effects were relatively important for consumption falls in Italy in 2007/08. I show that the estimated propensity for total consumption to respond to the negative wealth shock is consistent with the predictions of a dynamic-stochastic lifecycle model. This model is carefully constructed to capture features of the period, notably including the possibility of large wealth shocks in the stochastic process for returns to financial assets. Also consistent with the model, the results show stronger wealth effects for agents who were pessimistic about stock returns. Finally, my results point to noticeable effects on the labour supply behaviour of those who suffered larger shocks.
The Marie Skłodowska-Curie fellowship also gave me the opportunity to complete other works on individual and household choices within the life-cycle.

I disseminated the results of my research to the scientific community through articles, published or submitted to top journals, and working papers. I also presented the outcomes of my scientific activity at seminars in several European Universities and international conferences: Seminar at Leiden University (Invited); Seminar at University of Economics, Prague (Invited); Seminar at Birkbeck University of London (Invited); UCL, Applied Brown Bag Seminar; Seminar at Ca’ Foscari University of Venice (Invited); Seventh Italian Congress of Econometrics and Empirical Economics (ICEEE), Messina; 63rd Economic Policy Panel Meeting, Amsterdam; Journées Louis-André Gérard-Varet, Aix-en-Provence.

Progress beyond the state of the art and expected potential impact (including the socio-economic impact and the wider societal implications of the project so far)

The contribution to the literature of the core analysis I carried out is threefold, and reflects the main milestones obtained through this project. First, under the assumptions of rational expectations and a Markov process for the permanent shock, the two components of income shock can be written as a function of income expectations and realizations (Pistaferri, 2001; Attanasio et al., 2017). More precisely, the permanent component is identified by revisions in income expectations, and the transitory shock is given by income innovation and deterministic factors. Therefore, I separately identify the evolution of permanent and transitory shocks during the two recessions. I also evaluate how these perceptions vary across cohorts. Second, I exploit information about the distribution of expected income to quantify perceived income uncertainty, which is measured at the individual level and not cross-sectionally (as done in Pistaferri (2001) and Attanasio et al. (2017). Finally, I contribute to the literature by illustrating how perceptions about the persistence of income shocks and income uncertainty relate to consumption expenditure. I first examine the relation between uncertainty and income shocks with household's consumption. I, then, set-up a simple life-cycle model and compare the predicted consumption path, for different cohorts, to the patterns we observe in the data. This exercise allows us to gauge the relevance of the channels we analyze in explaining the extraordinary shrink in households' consumption expenditure during the last recession.
Moreover, I examined other aspects of households’ consumption and labor supply during the Great Recession. These results further contribute to the understanding of individual and household behavior in recession periods.
The analysis I carried out during the MSCA fellowship has relevant policy implications and offer an instrument in the hand of policymakers to understand some aspects of the recent economic and financial crisis. Given the topical subject, investigating the determinants of the economic crisis contributes to inform the economic and policy debate in Europe. The studies I implemented provide policymakers with a useful tool to understand households’ choices and, thus, implement effective interventions in sustaining consumption and hampering economic downturns.
Finally, the Marie Skłodowska-Curie fellowship allowed me to consolidate my knowledge, to acquire new skills, to consolidate my professional maturity and to attain an independent position as a researcher. I strengthened my international networking, by interacting with outstanding scholars and by starting new collaborations with other research in European Universities (e.g. University of Oxford), which are the basis for long-term international collaborations.

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