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CEP discussion paper
Consumption Smoothing and the Welfare Cost of Uncertainty
Yonas Alem and Jonathan Colmer
August 2015
Paper No' CEPDP1369:
Full Paper (pdf)

JEL Classification: I31; O13; Q12; Q56

Tags: income uncertainty; consumption smoothing; subjective well-being; anticipatory utility; rainfall variability

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.