Consumption and income smoothing

Abstract

This paper presents a two sector dynamic general equilibrium model in which income smoothing takes place within the households (intra-temporally), and consumption smoothing takes place among the households (inter-temporally). Idiosyncratic risk sharing within the family is based on an income smoothing contract. There are two sectors in the model, the regular sector and the underground sector, and the smoothing comes from the underground sector, which is countercyclical with respect aggregate GDP. The paper shows that the simulated disaggregated consumption and income series (that are the regular and underground consumption flows) are more sensitive to exogenous changes in sector-specific productivity and tax rates than regular and underground income flows, and that this picture is reversed when the aggregate series are considered.