Reexamining the excess sensitivity of consumption to income
The role of liquidity constraints
The finding that consumption is ‘excessively sensitive’ to current income is mostly blamed on the presence of liquidity constraints. This thesis extends the current literature and examines the relationship between excess sensitivity, household debt and the unemployment rate for a panel of 17 OECD countries over the period 1995-2015. The findings suggest that excess sensitivity is lower with higher levels of debt and lower unemployment rates, and that consumption is also sensitive to debt growth. These results have important implications for fiscal and monetary policy since the effectiveness of both depend on the way consumers react to changes in income and credit supply.