| This dissertation is comprised of two essays on the importance of two consumption smoothing mechanisms.;The first essay studies whether bankruptcy laws provide households with a way to insure consumption against adverse income shocks. Under Chapter 7 of the United States Bankruptcy Code, after a household files for bankruptcy it receives a discharge from its unsecured debts. In return, the household must give up any assets above an exemption level determined by law. That exemption insures part of a household's wealth in the face of negative income shocks, such as a layoff. Bankruptcy law, however, also increases the probability of bankruptcy, and reduces the value of debt repayments. Lenders may thus respond to higher exemptions by reducing the supply of credit. We test whether, conditional on having experienced a job loss, households in high-exemption states reduce their expenditures on food more (or less) than households in low-exemption states. Using data from the Panel Study of Income Dynamics (PSID) from 1976 through 2003, matched to state-level data on exemptions, we find that households that experience an involuntary job loss reduce their consumption more if they live in states with higher bankruptcy exemptions. The estimated coefficients are, however, too large to fit our hypothesis, given plausible economic parameters. That bankruptcy exemptions hinder consumption smoothing through a reduction in the supply of credit is, at best, an incomplete story.;The second essay measures the size of precautionary savings, another mechanism for consumption smoothing. In particular, it is demonstrated how separating business owners from non business owners makes a big difference in the empirical measurement of precautionary balances. Not properly accounting for differences between business owners and non business owners in studies of household wealth can lead to erroneous conclusions about the significance of different saving motives. Using data from the PSID from the 1980s and 1990s, we show that within samples of both business owners and non business owners, the amount of precautionary savings with respect to labor income risk is modest and accounts for less than 10 percent of total household wealth. Previous large estimates of the size of precautionary balances resulted from pooling these two groups together. Such pooling is inappropriate given that business owners face higher labor risk and accumulate more wealth than non business owners for reasons unrelated to precautionary motives. |
