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Does Income Inequality Lead to Consumption Inequality?

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Author Info
Krüger, Dirk
Perri, Fabrizio

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Abstract

This Paper first documents the evolution of the cross-sectional income and consumption distribution in the US in the past 25 years. Using data from the Consumer Expenditure Survey we find that a rising income inequality has not been accompanied by a corresponding rise in consumption inequality. Over the period from 1972-98 the standard deviation of the log of after-tax labor income has increased by 20% while the standard deviation of log consumption has increased less than 2%. Furthermore income inequality has increased both between and within education groups while consumption inequality has increased between education groups but mildly declined within groups. We then argue that these empirical findings are consistent with the hypothesis that an increase in income volatility has been an important cause of the increase in income inequality, but at the same time has lead to an endogenous development of credit markets, allowing households to better smooth their consumption against idiosyncratic income fluctuations. We develop a consumption model in which the sharing of income risk is limited by imperfect enforcement of credit contracts and in which the development of financial markets depends on the volatility of the individual income process. This model is shown to be quantitatively consistent with the joint evolution of income and consumption inequality in US, while other commonly used consumption models are not.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3583.

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Date of creation: Oct 2002
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Handle: RePEc:cpr:ceprdp:3583

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Related research
Keywords: consumption inequality limited enforcement risk sharing

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Find related papers by JEL classification:
D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies

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References listed on IDEAS
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    Other versions:
  4. Richard Blundell & Ian Preston, 1998. "Consumption Inequality And Income Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 113(2), pages 603-640, May. [Downloadable!] (restricted)
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  5. Deaton, Angus & Paxson, Christina, 1994. "Intertemporal Choice and Inequality," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 437-67, June. [Downloadable!] (restricted)
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  6. Dirk Krueger & Fabrizio Perri, 1999. "Risk sharing: private insurance markets or redistributive taxes?," Staff Report 262, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  7. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Blackwell Publishing, vol. 60(4), pages 865-88, October. [Downloadable!] (restricted)
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  12. Zhang, Harold H, 1997. " Endogenous Borrowing Constraints with Incomplete Markets," Journal of Finance, American Finance Association, vol. 52(5), pages 2187-2209, December. [Downloadable!] (restricted)
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    Other versions:
  14. Nelson, J.A., 1993. "On Testing for Full Insurance Using Consumer Expenditures Survey Data," Papers 93-02, California Davis - Institute of Governmental Affairs.
  15. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-98, May.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Mitra, Pradeep & Yemtsiv, Ruslan, 2006. "Increasing inequality in transition economies : is there more to come?," Policy Research Working Paper Series 4007, The World Bank. [Downloadable!]
  2. Giorgio E. Primiceri & Thijs van Rens, 2006. "Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality," Economics Working Papers 945, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2008. [Downloadable!]
    Other versions:
  3. Hanno Lustig & Stijn Van Nieuwerburgh, 2004. "A Theory of Housing Collateral, Consumption Insurance and Risk Premia," NBER Working Papers 10955, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Krebs, tom & Krishna, Pravin & Maloney, William, 2005. "Trade policy, income risk, and welfare," Policy Research Working Paper Series 3622, The World Bank. [Downloadable!]
    Other versions:
  5. Heathcote, Jonathan & Storesletten, Kjetil & Violante, Giovanni L, 2004. "The Cross-Sectional Implications of Rising Wage Inequality in the United States," CEPR Discussion Papers 4296, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  6. Hanno Lustig, 2004. "Can Housing Collateral Explain Long-Run Swings in Asset Returns? (joint with Stijn Van Nieuwerburgh)," UCLA Economics Online Papers 322, UCLA Department of Economics. [Downloadable!]
  7. Fatih Guvenen & Burhanettin Kuruscu, 2007. "A Quantitative Analysis of the Evolution of the U.S. Wage Distribution: 1970-2000," NBER Working Papers 13095, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Giorgio Primiceri & Thijs van Rens, 2002. "Inequality over the Business Cycle: Estimating Income Risk Using Micro-Data on Consumption," Economics Working Papers 943, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2004. [Downloadable!]
    Other versions:
  9. Richard Blundell & Hamish Low & Ian Preston, 2004. "Income risk and consumption inequality: a simulation study," IFS Working Papers W04/26, Institute for Fiscal Studies. [Downloadable!]
  10. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis. [Downloadable!]
    Other versions:
  11. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2000. "Consumption and Risk Sharing Over the Life Cycle," NBER Working Papers 7995, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  12. Anthony B Atkinson, 2003. "Income Inequality in OECD Countries: Data and Explanations," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  13. Christian E. Weller, 2007. "Have Differences in Credit Access Diminished in an Era of Financial Market Deregulation?," Working Papers wp144, Political Economy Research Institute, University of Massachusetts at Amherst. [Downloadable!]
  14. Heather Boushey & Christian E. Weller, 2006. "Inequality and Household Economic Hardship in the United States of America," Working Papers 18, United Nations, Department of Economics and Social Affairs. [Downloadable!]
  15. Erich Battistin, 2002. "Errors in Survey Reports of Consumption Expenditures," 10th International Conference on Panel Data, Berlin, July 5-6, 2002 C4-2, International Conferences on Panel Data. [Downloadable!]
  16. Erich Battistin, 2003. "Errors in survey reports of consumption expenditures," IFS Working Papers W03/07, Institute for Fiscal Studies. [Downloadable!]
  17. Audra J. Bowlus & Jean-Marc Robin, 2002. "Twenty years of rising inequality in US lifetime labor values," Research Unit Working Papers 0105, Laboratoire d'Economie Appliquee, INRA. [Downloadable!]
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