Employing Korean aggregate and household panel data, we examine the
asymmetry in household’s consumption responses to income changes, and
investigates whether the presence of liquidity constraint can explain this
asymmetry as predicted by existing theories. Testing the presence of
asymmetry in consumption responses, we find that in both aggregate and
household panel data, consumption decreases more significantly in response to
an income decrease than it increases in response to an income increase of the
same magnitude. When we split the households sample into
liquidity-constrained and unconstrained sub-groups, the asymmetry in
consumption responses is more prominent in the liquidity-constrained group.
Applying Shea(1995a) model to household panel data, we find that the
sub-group results support the liquidity constraint hypothesis as a convincing
explanation for the asymmetric responses of consumption.