This study examines empirically the permanent income/life cycle hypothesis (PIH/LCH) using household-level data from Korean family survey. We consider recent economic crises including the 1997 Asian financial crisis and the 2003 “credit card crisis” and analyze samples split into two groups based on income risk and level.
 

Recent empirical studies testing the PIH/LCH are based on exogenous information for income changes. From the classification of the head of household, we take the group of regular labor workers who have a salary contract and use the information as predictable income changes. This approach allows us to construct more powerful tests than using instrumental variables.

The empirical results do not support the PIH/LCH which consumption does not respond to anticipated income changes, so the presence of excess sensitivity of consumption is confirmed. General theory which excess sensitivity of consumption includes liquidity constraint. However, empirical results do not provide hard evidence to support the theory. Rather, results using the components of nondurable consumption are consist with the theory of “near rationality” suggested by Parker(1999).

Results from split sample considering two economic crises confirm the existence of excess sensitivity of consumption across different groups for a different sample period. For those in the high income bracket with highly secure jobs(Group 1), empirical results present that consumption does not respond to anticipated income changes after the crises between 1999 through 2004. Therefore, unlike an economic boom when similar patterns are observed among different risk groups in terms of consumer’s behavior, Group 1 takes a rational decision for consumption plan during a recession. 

Another empirical evidence for upper income group with lower liquid asset in 1998 does not support liquidity constraints during economic crises. However, consumption of upper income group does not respond to anticipated income changes, but consumption of lower income group does.

In conclusion, liquidity constraint is not the main causes for excess sensitivity of consumption for Korean case. In economic recession, upper income group makes a rational consumption decision to keep an optimal consumption plan. The empirical evidence casts doubt on the validity of policies that provide support for low liquidity households to mitigate liquidity constraints.