This dissertation explores how households allocate their financial resources across expenditure categories and over time. The interaction between income changes and consumption is important for the well-being of households. This interaction exhibits great heterogeneity across goods as well as across wealth. Notably, when the households are liquidity-constrained, their budget allocation decision is altered substantially. This dissertation analyzes the interaction between household income and intertemporal budget allocation with an emphasis on liquidity constraints.

In the first chapter, I explore how the liquidity constraints affect the household intertemporal allocation of consumption differentially across wealth and across expenditure categories. This chapter comprises two sub-chapters for the theoretical and empirical evaluation of the effect of binding liquidity constraints on intertemporal budget allocation. Further, the chapter compares the effect of liquidity constraints on healthcare expenditure with the effect on non-health consumption in particular on food consumption. I extend a standard incomplete markets model with a health capital in the felicity function. Theoretically, I show that households reduce their healthcare expenditure due to the binding liquidity constraints in the current period, whereas expenditure declines in the next period due to the expected binding constraints one period ahead. I use the extended model to test the incidence of binding liquidity constraints with a linearized Euler equation. Empirically, I show that the test of liquidity constraints for healthcare expenditure reveals different implications than a standard test of liquidity constraints for nondurable consumption. In particular, current binding constraints and expected binding constraints lead to the opposite direction of bias when the liquidity constraints are omitted. The resulting overall bias depends on which constraint has a stronger effect. Moreover, the correlation between income and healthcare expenditure varies significantly between asset poor and rich families, more than the elasticity of non-health consumption among wealth quintiles. Altogether, my findings show that the effects of liquidity constraints are heterogeneous across households and across expenditure categories.

In the second chapter, I estimate the income elasticity of consumption for various expenditures. Estimating income elasticity of consumption is found to be a challenging task. The causal impact of income changes on expenditure is hard to measure due to the endogeneity of the treatment variable income. I use a shift-share instrumental variable design `a la Bartik [1991] to mitigate the endogeneity concerns by exploiting variation due to local labor market exposure to aggregate shocks. I estimate the income elasticity of consumption that results from the changes in national employment growth in industries weighted with regional employment share of the industry. I find an average elasticity of total household consumption in the ranges between 0.4 to 0.53 depending on the construction of the instrument. Food consumption elasticity ranges between 0.11 to 0.2 though is not significantly estimated. Of particular interest for income elasticity estimates is the household out-of-pocket healthcare expenditure which has an elasticity of around 3.14 to 3.59. This finding adds to the discussion of health spending being a luxury good with an elasticity above one which is found in aggregate cross-country or time-series estimates. I find elasticities above one using household-level micro consumption and regional employment growth data, whereas micro studies usually conclude health expenditure elasticities around zero.

In the third chapter, I provide a detailed analysis of household wealth and portfolio allocation. This chapter presents several stylized facts on how households allocate wealth among asset classes, how portfolio allocation changes over the lifecycle and over the business cycle, and how portfolio and income are related. The chapter combines various survey data to show that household income and portfolio allocation are highly correlated especially for middle-income households. Asset accumulation has an inverted-V shape over the lifecycle whereas debt is front-loaded in working ages. Income and consumption follow a hump-shaped over the lifecycle. Old households hold assets in liquid forms. As for the business cycle, the Great Recession has devastating effects on the welfare of households such that both networth and consumption declined, and poverty rates increased. The effect is more severe for non-white, low educated, and female-headed households.