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CEP discussion paper

Consumption smoothing and the welfare cost of uncertainty

What is the effect of income uncertainty on individual well-being? Combining individual-level panel data from rural Ethiopia with high-resolution meteorological data, we estimate that mean-preserving increases in rainfall variability are associated with reductions in objective consumption and subjective well-being. We show that the reductions in consumption, through precautionary savings, explain only 14-21% of the total effect on individual well-being. Increased uncertainty has a direct effect on individual well-being, above and beyond its effects on consumption. These findings suggest that the gains from further consumption smoothing are likely greater than estimates based solely on realized consumption fluctuations.

Yonas Alem and Jonathan Colmer

1 August 2015     Paper Number CEPDP1369

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This CEP discussion paper is published under the centre's Growth programme.