Asymmetry in Consumption and Its Implication for Tax Policy

Abstract

If agents are liquidity constrained, more agents are likely to be liquidity constrained during contractions than expansions, and hence consumption would be more sensitive to current income during contractions than expansions. If agents are myopic, on the other hand, the consumption sensitivity should be symmetric. I find that consumption is more sensitive to current income in contractions than in expansions, and conclude that agents are liquidity constrained rather than myopic. Futhermore, during expansions, i find that consumption is less likely to be too sensitive to current income and the permanent income hyphothesis(PIH) is less likely to be rejected. During contractions, consumption is more likely to be too sensitive to current income and the PIH is more likely to be rejected. US consumption exhibits an asymmetric behavior.