Abstract:
Institutions meant to reallocate risks that cannot be fully diversified on financial
markets, such as labour income fluctuations, may also affect the response of aggregate
consumption to country-specific income shocks. This paper empirically assesses this
possibility by extending a standard cross-country consumption insurance test to account
for the interaction between macroeconomic shocks and labour and credit market
institutions. In a panel of 15 OECD countries observed over the 1971-2003 period,
institutional heterogeneity is a significant determinant of cross-country differences in
consumption responsiveness to income changes. The estimates are remarkably robust to
the inclusion of unobservable country-level heterogeneity and time-varying institutional
indicators.
