1999 Reports

Forward-looking behavior, precautionary savings, and borrowing constraints in a poor, agrarian economy: tests using rainfall data

Chaudhuri, Shubham

Household in many poor, agrarian economies derive their income from rain-dependent agriculture. This dependence raises the possibility that, from rainfall patterns early on in the crop-cycle, households accumulate information about future cash inflows (e.g., harvests) before the cashflows are realized. Using detailed longitudinal data from three villages in India, this paper explores whether households utilize this information in the ways suggested by modern consumption theories. Two of the central hypotheses suggested by these theories are that households are forward-looking in their consumption behavior and the react optimally to the receipt of information; and that in the face of uncertainty about future incomes, households engage in precautionary saving. The basic challenge in implementing tests of these hypotheses has been to find empirical measures of the 'news' that households receive, and the uncertainty they face. I show that, in the villages I study, rainfall patterns provide good proxies from which such measures might be constructed. I exploit this fact to test for precautionary saving and forward looking behavior. I find that precautionary saving and forward-looking behavior do not, by themselves, fully explain the observed consumption patterns. However, when I explicitly incorporate the possibility of binding borrowing constraints into the testing strategy, I obtain fairly strong support for the joint hypothesis of precautionary saving and forward-looking behavior in the presence of borrowing constraints.