How Much Does Money Really Matter? Estimating the Causal Effects of Income on Happiness

There is a long tradition of psychologists finding small income effects on life satisfaction (or happiness). Yet the issue of income endogeneity in life satisfaction equations has rarely been addressed. This paper aims to do just that. Instrumenting for income and allowing for unobserved heterogeneity result in an estimated income effect that is almost twice as large as the estimate in the basic specification. The results call for a reevaluation on how the calculation of compensatory packages to various shocks in the individual's life events should be designed