Reading Report # 2

“Consumption and Debt Response to Unanticipated Income Shocks:

Evidence from a Natural Experiment in Singapore”.
- Sumit Agarwal and Wenlan Qian

ECO603: Advanced Econometrics

Submitted to:

Chen Zhihong
Professor, SITE, UIBE

Submitted by:

Syed Nazrul Islam

Student ID: DE201760011

Dated: 29 November 2017

 “Consumption and Debt Response to Unanticipated Income Shocks: Evidence from a
Natural Experiment in Singapore”.
1. The question to be investigated and why it is meaningful:
The paper attempts to analyze how consumption and debt respond to an unanticipated fiscal
stimulus program.
It is argued that while consumption should not respond to anticipated income changes, it should
respond to unanticipated income changes (Jappelli and Pistaferri, 2010). In literature there are a handful
of studies that examined anticipated income shocks on consumption. But a few papers are concerned
with unanticipated income shocks due to identification problems of income shock that are truly
exogenous and unanticipated. Based on a unique policy announcement by the Singapore Government
on February 18, 2011(so called growth dividend program) which is exogenous, the paper examines the
effect of fiscal stimulus on people’s consumption and debt and estimates both announcement effect and
disbursement effect 1 . Governments of many countries take fiscal stimulus packages to boost
consumption especially during recession. The study, therefore, is a meaningful one for policy makers
and researchers too to know the effect of unanticipated policies to economic activities.
2. The assumptions of the paper and if they are legitimate:
The life-cycle theory has a clear prediction that consumers should respond to the announcement of an
unanticipated income shock. In addition, the permanent income hypothesis suggests that the magnitude
of the consumption response is equal to the real interest rate in a complete market in an infinite horizon,
but higher in the finite horizon. Moreover, when consumers face borrowing constraints or when
precautionary saving motives are strong as the unanticipated income increase reduces the income
uncertainty, the consumption respond could be significant.
Considering this theoretical perspective, the paper constructs its experimental design and a matched
sample of Singaporeans (treatment) and foreigners2 (control) that are observationally similar. The paper
tests the life cycle theory by decomposing the post policy window into the announcement period and
disbursement period. Accordingly, the paper hypothesize that the monthly total card spending response
is the same between the announcement and disbursement period. The assumptions and hypothesis are
appropriate for examining the research question in line with the theory of consumer behavior.
3. The data set used in the paper:
The researchers use a unique balanced panel dataset of consumer financial transactions. The dataset
has been obtained from the leading bank in Singapore that has a customer base about 80% of the
entire population of Singapore. They paper uses randomly chosen more than 180,000 consumers in
Singapore as representative sample of the chosen bank’s customers and study how their credit card,
debit card and checking account spending behavior responded to positive income shock. They study
covers the period financial transactions of the individuals during 2010:04 to 2012:03; however, the
final sample period is from 2010:08 to 2011:11. The pretreatment period is from 2010:08 to 2011:01
and post-treatment period is from 2011:01 to 2011:11. The sample is divided into two parts:
treatment group (Singaporeans) and control group (foreigners). As the control group is not directly
comparable to treatment group due to several key dimensions, the researchers, then construct a
matched sample of treatment and control groups that are observationally similar3. The paper also
explicitly tests any differences between the treatment and control group and carries out robustness
checks to validate matched sample approach.
4. The theoretic model:
The paper does not describe any specific theoretical model. However, the economic background of
the paper is based on the life-cycle theory [as stated in section 2].
5. The empirical method:
The paper analyzes the response in spending and debt using difference-in-differences regression
methodology.

1
The said fiscal stimulus was announced in February, 2011 and disbursement was made in April 2011.
2
Foreigners, constituting 40% of Singapore population, did not qualify for the growth dividend program.
3
The researchers use logistic regression to match observations and result is not included in the paper.
First, the average monthly response to the stimulus is studied using the following specification:
Yi,t= βpre X $Di X 1pre + βpost x $Di X 1post + αi + δt +ε i,i … … … (1)
where Yit is the dollar amount of total card spending, $Di is the amount of growth dividend in the
treatment group (=0 for the control group), 1pre is a binary variable equal to 1 for the months before the
announcement, 1post is a binary variable equal to 1 for the months after the announcement, δi is the year-
month dummy (to absorb seasonal variation in consumption), αi is the individual dummy (to absorb
differences in consumption preferences).
To compare the policy effect in of the post policy window into the announcement period and
disbursement period, the paper then uses the following specification-
Yi,t= βpre X $Di X 1pre + βa X $D¡ X 1announce +βd X $D¡ X 1disburse + αi + δt + εi,t. … … … (2)
where 1announce is a binary variable equal to 1 for the two months during the announcement window
and 1disburse is a binary variable equal to 1 for the months after disbursement. To study the dynamics of
the spending or debt change response the paper estimates the distributed lag model which is
specified as-
Yi,t =∑ s X $Di X 1month s + αi + δt + εi,t … … …. (3)
Finally, the paper studies heterogeneity in the the response of growth dividend across different groups
of individuals using the following specification:
Yi,t =∑ s X $Di X 1month +∑ g1,sX 1g1X$Di x1month s + …
+∑ g(N-1),s X 1g(N-1)X$Di X1month s+ αi + δt + εi,t … … … (4)
where N is the number of subgroups of consumers.
6. The summary of results:
Most of the regression coefficients are found to be significant at 5% and 1% level of significance.
The estimated results show that consumption rose significantly after the fiscal announcement: for $1
received, consumers on average spent $0.80 during the ten months after the announcement.
Consumer’s credit card debt moderately decreased during this period. The regression results also
show a strong announcement effect (19% spending increase before the cash payout). Prior to the
announcement, there is no difference in consumption trend between the treatment and control groups.
The researchers find that the consumers started spending via credit cards during the announcement
periods, and then switched to debit cards after disbursement. Consumption response is found to be
heterogeneous across spending categories and across individuals. The paper also performs tests for
robustness of its results and finds that robustness tests are qualitatively and quantitatively similar to
those in the main analysis.
7. The contribution and limitation of the paper and the possible extension:
As claimed by the researchers, the paper first documented experimentally the announcement effect
on consumption trend of stimulus program which is consistent with life-cycle theory predictions on
consumption response to unanticipated income shocks. The paper has been successful to decompose
the consumption response into different spending instruments which has likely to be underestimated
in prior work based on micro data from one single payment instrument. Moreover, the paper
documents dynamics of consumption response across different spending instruments.
It seems, however, that the paper has some limitations. If a cash dividend program is associated with
simultaneous increase in direct taxes (e.g. income tax) and indirect taxes (e.g. sales tax), the
responsiveness could be different than the estimated. The paper does not explain any such measures
taken by Singapore Government during the study period. Nevertheless, the paper has tremendous
implications on future research. Based on the methodology of this paper, the impact of fiscal stimulus
can be analyzed on the behavior of investors (assumed to be different than a rational consumer) due
to stock market collapse.
8. The publication information such as the journal, issue and year:
Researchers: Sumit Agarwal and Wenlan Qian (Business School, National University of Singapore).
Journal Information: The American Economic Review, Vol. 104, No.12 (Dec. 2014),PP-4205-4230.