The transmission mechanism analysis of the impact of economic policy uncertainty on household consumption

Abstract Economic policy uncertainty is proven to have an important effect on household consumption. However, the literature on its transmission mechanism and on comparing the consumption response of urban and rural households, especially in China, is limited. In this paper, we propose two channels through which economic policy uncertainty affects household consumption, the precautionary saving channel and the investment‐employment channel. Then, we use the household survey data (China Health and Nutrition Survey) to explore the heterogeneous effect among urban and rural households. We verify that an increase in economic policy uncertainty can significantly reduce household consumption through both channels. Further, the precautionary saving channel is more important in the urban household sample, while the investment‐employment channel is more pronounced in the rural household sample. In addition, the heterogeneous effect also exists across households in different regions. Our results are robust with consideration of different estimation methods, the lagged effect of the uncertainty, and other characteristics of households.