SWITCHING REGRESSION ESTIMATES OF THE INTERGENERATIONAL PERSISTENCE OF CONSUMPTION

I. INTRODUCTION Since the seminal work of Friedman (1957) and Modigliani and Brumberg (1954), the fact that life-cycle consumption is much smoother than income has been established as one of the cornerstones in macroeconomics. Economic agents are able to optimize on their life-cycle consumption via the means of saving and borrowing. Similarly, family dynasties may be able to optimize on their lifetime consumption across generations through the channel of intergenerational transfers. However, despite strong evidence of the massive intergenerational asset transfers (Kotlikoff and Summers 1981), few studies-except perhaps Mulligan (1997, 1999) and Waldkirch, Ng, and Cox (2004) (1)--have explored the intergenerational dynamics of consumption. By contrast, there is a large body of estimates on intergenerational relationships in income or earnings, for the United States and for other countries around the world. (2) Investigating the intergenerational consumption relationship would complement our knowledge of the relationship of intergenerational income or earnings. Consumption is a more direct measure of economic well-being than income. Furthermore, understanding the intergenerational effects of parental financial transfers on consumption would be helpful for sensible public policy design. If parents are transferring resources in various forms (including financial transfers) in an optimal manner to promote their offspring's overall well-being, then government transfer programs that target disadvantageous individuals at specific life stages through specific channels (e.g., education financial aids, or food stamp programs) may replace or crowd out parental inputs without achieving the same optimal effects on the overall well-being of these individuals. Broadly, our study is linked to the question of how to interpret parental financial transfers to their adult children. (3) Financial transfers from parents can occur in the form of inter vivos (i.e., between living persons) gifts, (4) or bequests. (5,6) The literature has debated on whether post-education financial transfers are driven by parental altruism, or by an exchange arrangement in return for services delivered or expected to be delivered from adult children. Previous studies have found evidence that inter vivos transfers are consistent with both motives (Cox 1987, 1990), (7) yet bequest transfers consistent with neither (Tomes 1981; Wilhelm 1996). McGarry (1999) showed that an altruistic parent makes inter vivos transfers to ease his child's liquidity constraints (therefore strongly related to her current income), and arranges bequest transfers in response to the child's permanent income (therefore only partially related to her current income). Our study is more closely linked to the view that treats bequest receipt as a signal of access to credit markets for human capital investments. Becker and Tomes (1986) argued that altruistic parents leave financial bequests to children only after they have made efficient human capital investments in their children. Under imperfect credit markets, there are credit constrained parents who cannot self-finance these investments without forgoing own consumption that has an opportunity cost higher than the market interest rate. This results in a lower consumption transmission from parents to children in constrained families. Besides signaling access to credit markets, financial transfers including bequests enable a parent to guard his/her offspring against any relative downward trending of consumption that arises from relative downward trending of lifetime income, thus contribute to a higher degree of persistence in consumption. From this perspective, the total welfare cost of credit constraints goes beyond what is revealed by education achievement or lifetime income, and the benefit of being born in a richer family is not limited to being able to afford elite education. This study tests the connection between credit constraint and intergenerational consumption persistence, using bequest receipt as the signal of constraint status for the parental households. …