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Debt-Constraints or Incomplete Markets? A Decomposition of the Wealth and Consumption Inequality in the U.S

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  • Juan-Carlos Cordoba

    (Rice University)

Abstract

The large wealth and consumption inequality in the U.S. is usually attributed to two market frictions: debt constraints and incomplete markets. Recent literature has argued that debt constraints are the critical friction while market incompleteness plays only a secondary role. We evaluate the independent role of debt constraints versus market incompleteness to explain U.S. inequality. We introduce full insurance opportunities in a standard model of inequality along the lines of Aiyagari (1994). Debt constraints are the only friction in such model. We find that for a quite standard calibration of the income process, that of Heaton and Lucas (1996), debt constraints alone can explain none of the observed inequality. The reason is that the U.S. capital stock would be enough to secure all required contingent debts if markets were completed. Using various non-standard calibrations, we find that debt constraints can play an important role to explain inequality but still market incompleteness remains as the main friction. In particular, debt- constrained models cannot account for the large wealth dispersion and wealth concentration in the top tail of the distribution in the U.S.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0404004.

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Length: 37 pages
Date of creation: 05 Apr 2004
Date of revision:
Handle: RePEc:wpa:wuwpma:0404004

Note: Type of Document - pdf; pages: 37
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Web page: http://128.118.178.162

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Keywords: Idiosyncratic Risk; Incomplete Markets; Borrowing Constraints; Wealth Distribution;

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  1. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  2. Debreu,Gerard Introduction by-Name:Hildenbrand,Werner, 1986. "Mathematical Economics," Cambridge Books, Cambridge University Press, number 9780521335614, April.
  3. Felix Kubler & Karl Schmedders, 2001. "Incomplete Markets, Transitory Shocks, and Welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 747-766, October.
  4. Calvet, Laurent E., 2001. "Incomplete Markets and Volatility," Journal of Economic Theory, Elsevier, vol. 98(2), pages 295-338, June.
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  8. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 1998. "Mutual Insurance, Individual Savings and Limited Commitment," Keele Department of Economics Discussion Papers (1995-2001) 98/14, Department of Economics, Keele University.
  9. George-Marios Angeletos & Laurent Calvet, 2003. "Idiosyncratic Production Risk, Growth, and the Business Cycle," NBER Working Papers 9764, National Bureau of Economic Research, Inc.
  10. Chatterjee, Satyajit, 1994. "Transitional dynamics and the distribution of wealth in a neoclassical growth model," Journal of Public Economics, Elsevier, vol. 54(1), pages 97-119, May.
  11. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June.
  12. Orazio Attanasio & Erich Battistin & Hidehiko Ichimura, 2004. "What Really Happened to Consumption Inequality in the US?," NBER Working Papers 10338, National Bureau of Economic Research, Inc.
  13. David K. Levine & William Zame, 2001. "Does Market Incompleteness Matter," Levine's Working Paper Archive 78, David K. Levine.
  14. Harold L. Cole & Narayana R. Kocherlakota, 1999. "Efficient allocations with hidden income and hidden storage," Staff Report 238, Federal Reserve Bank of Minneapolis.
  15. Patrick J. Kehoe & Fabrizio Perri, 2000. "International Business Cycles with Endogenous Incomplete Markets," NBER Working Papers 7870, National Bureau of Economic Research, Inc.
  16. Huggett, Mark, 1996. "Wealth distribution in life-cycle economies," Journal of Monetary Economics, Elsevier, vol. 38(3), pages 469-494, December.
  17. David Domeij & Jonathan Heathcote, 2004. "On The Distributional Effects Of Reducing Capital Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 523-554, 05.
  18. Ligon, Ethan & Thomas, Jonathan P & Worrall, Tim, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 209-44, January.
  19. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-98, May.
  20. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2004. "Cyclical Dynamics in Idiosyncratic Labor Market Risk," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 695-717, June.
  21. Schechtman, Jack & Escudero, Vera L. S., 1977. "Some results on "an income fluctuation problem"," Journal of Economic Theory, Elsevier, vol. 16(2), pages 151-166, December.
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