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Consumption smoothing and the welfare cost of uncertainty

Alem, Yonas and Colmer, Jonathan (2015) Consumption smoothing and the welfare cost of uncertainty. CEP Discussion Papers (CEPDP1369). London School of Economics and Political Science. Centre for Economic Performance, London, UK.

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When agents are unable to smooth consumption and have distorted beliefs about the likelihood of future income realisations, uncertainty about future states of the world has a direct effect on individual welfare. However, separating the effects of uncertainty from realised events and identifying the welfare effects of uncertainty both present a number of empirical challenges. Combining individual-level panel data from rural and urban Ethiopia with high-resolution meteorological data, we estimate the empirical relevance of uncertainty on objective consumption and subjective well-being. While negative income shocks affect both objective consumption measures and subjective well-being, greater income uncertainty only has an affect on subjective well-being. A one standard deviation change in income uncertainty is equivalent to a one standard deviation change in realised consumption. These results indicate that the welfare gains from further consumption smoothing are substantially greater than estimates based solely on consumption fluctuations.

Item Type: Monograph (Discussion Paper)
Official URL:
Additional Information: © 2015 The Authors
Divisions: Centre for Economic Performance
Subjects: B Philosophy. Psychology. Religion > BF Psychology
H Social Sciences > HC Economic History and Conditions
H Social Sciences > HV Social pathology. Social and public welfare. Criminology
JEL classification: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty
I - Health, Education, and Welfare > I3 - Welfare and Poverty
O - Economic Development, Technological Change, and Growth > O1 - Economic Development > O12 - Microeconomic Analyses of Economic Development
Date Deposited: 01 Oct 2015 10:14
Last Modified: 16 May 2024 12:06
Projects: Environment for Development Initiative, Human Cooperation to Manage Natural Resources
Funders: Economic and Social Research Council, Swedish International Development Agency, Gothenburg Centre for Globalisation and Development, Swedish Research Council Formas, Grantham Foundation

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