Intertemporal Choice and Consumption Mobility

The theory of intertemporal consumption choice makes sharp predictions about the evolution of the entire distribution of household consumption, not just about its conditional mean. In a first step, we study the empirical transition matrix of consumption using a panel drawn from the Bank of Italy Survey of Household Income and Wealth. In a second step, we simulate the transition matrix of the consumption distribution using parameters for the income process estimated on the same dataset. Comparison between the actual and the simulated transition matrix for consumption is favorable to the permanent income hypothesis once we allow for measurement error in consumption and a moderate degree of excess sensitivity to income shocks. The theory of consumption insurance is strongly rejected.