Gizem Kosar, NY Fed

Paper: Subjective Uncertainty and the Marginal Propensity to Consume

Abstract: Earnings uncertainty is central to most heterogeneous-household models. Yet, there is surprisingly little evidence on how subjective uncertainty is related to consumption behavior. Using unique data from the Survey of Consumer Expectations, we show that the marginal propensity to consume (MPC) is increasing and concave in individual-specific earnings growth uncertainty. In the workhorse consumption–savings model augmented with risk heterogeneity, MPCs decline with earnings uncertainty, contrary to the empirical evidence. We pinpoint which mechanisms, central to the model, create this disconnect. Embedding empirically disciplined biased beliefs in the otherwise canonical model reconciles the theory with the empirical findings.