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.
1 August 2015 Paper Number CEPDP1369
This CEP discussion paper is published under the centre's Growth programme.