Income Shocks and Their Transmission into Consumption

This paper reviews the economics literature of, primarily, the past 20 years that studies the link between income shocks and consumption fluctuations at the household level. We identify three broad approaches through which researchers estimate the consumption response to income shocks: (1) structural methods in which a fully or partially specified model helps identify the consumption response to income shocks from the data, (2) natural experiments in which the consumption response of one group that receives an income shock is compared with another group that does not, and (3) elicitation surveys in which consumers are asked how they expect to react to various hypothetical events.