> Posted by Anita Gardeva

Access to financial services creates calmer waters by smoothing consumption

Word of the Week – Consumption Smoothing: Reduction in the variability in consumption by households, often through the use of financial services.

Consumption smoothing is often cited as a benefit of access to financial services.  For many financially excluded households, income and consumption are volatile.  As explained in Portfolios of the Poor, “One of the least remarked-on problems of living on two dollars a day is that you don’t literally get that amount each day…you make more on some days, less on others, and often get no income at all.” Savings and loans allow people to tap into past income (through savings) or future income (through loans), helping them smooth consumption. Consumption smoothing can refer to short, medium, or life-cycle time horizons.

Spotlight Fact: Research has shown that access to financial services can reduce a household’s consumption variability by about 50 percent.  In other words, when faced with income shocks, households with access to microfinance experience the shock with half the severity of those without access.

Suggested Resources:
For a look at how poor families manage risk through income and consumption smoothing, and what the associated costs are, a good place to start is with Jonathan Morduch’s “Income and Consumption Smoothing,” The Journal of Economic Perspectives, Vol. 9 No. 3 (summer, 1995).

For a study that demonstrates the long-term effects on consumption smoothing of financial access: Nidhiya Menon, “Consumption Smoothing in Microcredit Programs,” (Manuscript, Brandeis University, August 2003).

For a detailed account of how the poor manage their resources and why they need formal financial services:  Daryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven, Portfolios of the Poor, (Princeton: Princeton University Press, 2009).

For more financial inclusion terms, please visit the Financial Inclusion Glossary.

For more information on CFI’s Financial Inclusion 2020 campaign, sign up for updates here. 

Flickr credit: richardefreedman