Income, Psychological Well-Being, and the Dynamics of Poverty

Evidence across disciplines suggests a bidirectional relationship between psychological and economic well-being and indicates a possible feedback loop that can reinforce poverty. Estimation of these causal links, however, is difficult because of this simultaneity. I use a panel generalized method of moments approach and a large-scale dataset from South Africa to estimate a system of dynamic equations where income and psychological well-being are simultaneously determined. I find evidence of heterogeneous effects in both directions that highlights the vulnerability of those among the poor who have low levels of psychological well-being. Simulations suggest this relationship can double the overall effect of shocks and explain prolonged poverty spells.