Does Public Income Induce More Consumption?*

Authors

  • ELLIOTT FAN

    1.  Social Policy Evaluation, Analysis, and Research (SPEAR) Centre, Research School of Social Sciences, Australian National University (ANU), Canberra, ACT, Australia
    Search for more papers by this author

  • *

     The author is grateful to Dwayne Benjamin, Michael Baker, Deborah Cobb-Clark, Aloysius Siow, Angelo Melino, Robert McMillan, Christine Neill and Azim Essaji.

Elliott Fan, Social Policy Evaluation, Analysis, and Research (SPEAR) Centre, Research School of Social Sciences, Australian National University (ANU), Coombs Building #9, Fellows Road, Canberra, ACT 0200, Australia. Email: elliott.fan@anu.edu.au

Abstract

The Life-Cycle/Permanent Income Hypothesis predicts that income uncertainty reduces an individual’s incentive to consume, while holding permanent income level constant. This implies that switching from a relatively unstable form of income to a stable one motivates consumption. This article explores this implication by quantifying and comparing the marginal propensity to consume (MPC) out of private income and income from a public pension scheme. It exploits the introduction of a public pension that provides a monthly fixed amount of payment – a relatively secure source of income. The results suggest that the provision of pension leads to a higher MPC for the beneficiaries’ households, and the estimated MPC out of the pension income is significantly larger than the corresponding estimate for private income. Further examination suggests that households facing more non-tradable risks appear to be more prudent on consumption, highlighting the role of income uncertainty in households’ consumption decisions.

Ancillary