Essays on consumption distribution and heterogeneity in household preferences

Abstract

Income interventions with pro-poor targeting is a common fiscal policy around the world. However, their corresponding distributional effects on consumption and savings are not well understood. In the first essay, using an Aiyagari - like economy with heterogenous households calibrated to Indian data, we show that the standard scheme of interventions that consistently targets low-income cohorts, has small distributional impacts on targeted and non-targeted cohorts. In contrast, a fiscally-equivalent scheme that changes the expected income profile of the targeted households in the same initial cohort irrespective of their future incomes, generates substantially larger effects by changing income mobility for both the targeted and non-targeted cohorts. This mobility-based channel generates consumption responses even though the magnitude of the shock is lesser for the initially targeted cohort, as it more than offsets the effect from permanent income shock. In the second essay, we estimate the preference parameters, time discount factor and elasticity of intertemporal substitution (EIS), for a set of Indian households. We assume power utility with constant coefficient of relative risk aversion and estimate these parameters using the Euler equation of consumption. We find substantial heterogeneity in these parameters across households. We observe a robust statistically significant negative relationship between the time discount factor and CRRA parameter. We find consistent patterns in sensitivities of preference parameters with household demographics. The third essay explores trade-offs in portfolio allocation of Indian households. A unique characteristic of an average Indian household according to a report by the Household Finance Committee in 2017 is that it holds around 11% of wealth in gold. In view of such a unique setting of household portfolio allocation we find that in the same sample of Indian households, a household would reduce their gold holding by 1% for a 0.41% increase in their holding in stocks, assuming power utility and optimal mean-variance portfolio allocation for each household in the sample. This trade-off was significantly affected by the demonetisation implemented by the Indian government in November 2016 which can be explained as a shock to the liquidity preference of the households. The assumption of mean-variance portfolio optimization rule might be slightly underestimating the share of gold in the sample.