Consumption Smoothing and Household Responses: Evidence from Random Exogenous Health Shocks

Abstract

Endogeneity in the health-wealth relationship is one of the biggest challenges in studying the causal effect of health on household consumption, wealth and labor responses. Using a novel study design, I present new evidence of causal effects of health shocks on consumption smoothing, household assets and debt. The empirical strategy relies on exogenous health shocks suffered as passengers injured in bus accidents, with "controls" drawn from travelers on the same bus routes, matched on age, gender and residential area. The matching strategy ensures that the exogenous health shocks from the bus accident are random, conditional upon matching. Using data from my household survey conducted one year after the accidents, I find evidence of imperfect consumption smoothing and large effects on household debt. Debt was the principal mechanism used by households to mitigate effects of the shock. The shock related expenses, equal on average to two months of household income, caused exposed households to reduce educational expenditures by roughly 20% and festival expenses by 9%. I find that the odds of having debt among exposed households were five times higher and the average size of debt was almost twice as much compared to the unexposed.