Expected and realized income changes: Evidence from the Dutch socio-economic panel.

Abstract

Income expectations play a central role in household decision making. In the life cycle model for example, consumption and savings decisions reflect expectations of future income. In empirical applications where direct information on expectations is not available, it is usually assumed that expectations are rational, and reflected by observed future realizations. In this paper, we analyze direct subjective information on expected changes of household income in one panel wave of Dutch families. First, we describe these data and investigate how the expectations can be explained by, among other variables, income changes in the past. Second, we combine these data with information on realized income changes in the next panel wave, and analyze the differences between expected and realized changes. We find that, on average, households underestimate their future income changes significantly. In particular, this holds for those families whose income has fallen in the past.