Income Shocks or Insurance – What Determines Consumption Inequality?☆

Contrary to the implications of economic theory, consumption inequality in the United States did not react to the increases in income inequality during the last three decades. This paper investigates if a change in the type of income inequality – from permanent to transitory – or a change in the ability to insure income shocks is responsible for this. A measure of household consumption is imputed into the Panel Study of Income Dynamics to create panel data on income and consumption for the period 1980–2010. The minimum distance investigation of covariance relationships shows that both explanations work together: the share of transitory shocks increases over time, but the capability to insure against permanent and transitory income shocks also improves. Together, these phenomena can explain the lack of an increase in consumption inequality.