Consumption Smoothing and Household Savings: Role of Demographics and Durables

Abstract

Canonical life-cycle models predict that rational, fully forward-looking agents should perfectly smooth consumption over their lifetime. This prediction, while not supported by the data, has been mostly tested for developed countries like the U.S. We use recently available, rich longitudinal data for a large sample of households to understand patterns of consumption expenditures, income growth, and savings rates in India. Our empirical analysis has several important findings. First, growth in total household consumption and income is comparable to that of the U.S. However, unlike the U.S., Indian households exhibit no growth in non-durable consumption expenditures after adjusting for family size. We document significant heterogeneity along with various population sub-groups, but none of them exhibit growth close to U.S. households. Savings rates, measured as total income net of non-durable expenditures, on the other hand, exhibit a strong hump over the life-cycle. We present evidence that the need to save for lumpy investments such as housing, cars, tractors, and cattle are key drivers of the high savings rate growth over the life-cycle for Indian households.

Keywords: consumption, savings rate, demographics, life-cycle, durables, asset accumulation, household heterogeneity, panel data, pseudopanel, equivalence scales.