DP14937 Scarred Consumption

Author(s): Ulrike M. Malmendier, Leslie Sheng Shen
Publication Date: June 2020
JEL(s): D12, D83, D91, G51
Programme Areas: Financial Economics, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14937

We show that economic downturns can "scar" consumers in the long-run. Having lived through times of high unemployment consumers remain pessimistic about the future financial situation and spend significantly less years later, controlling for income, wealth, and employment. Their actual future income is uncorrelated with past experiences. Due to experience-induced frugality, scarred consumers accumulate more wealth. Using a stochastic life-cycle model we show that the negative relationship between past downturns and consumption cannot arise from financial constraints, income scarring, or unemployment scarring. Our results suggest a novel micro-foundation of fluctuations in aggregate demand and imply long-run effects of macroeconomic shocks.