A Network Approach to Expenditure Cascades

currentThe nexus between debt and inequality has attracted considerable scholarly attention in the wake of the global financial crisis. One prominent candidate to explain the striking co-evolution of income inequality and private debt in this period has been the theory of upward-looking consumption externalities leading to expenditure cascades. We propose a parsimonious model of upward-looking consumption at the micro-level mediated by perception networks with empirically plausible topologies. This allows us to make sense of the ambiguous empirical literature on the relevance of this channel. Our model, based purely on income, replicates the major stylised facts regarding micro consumption behaviour and is thus observationally equivalent to the workhorse permanent income hypothesis, without facing its dual problem of “excess smoothness” and “excess sensitivity”. We also demonstrate that the network topology and segregation has a significant effect on consumption patterns which has so far been neglected.