Heterogeneous life-cycle profiles, income risk and consumption inequality

Was the increase in income inequality in the US due to permanent shocks or merely to an increase in the variance of transitory shocks? The implications for consumption and welfare depend crucially on the answer to this question. We use Consumer Expenditure Survey (CEX) repeated cross-section data on...

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Bibliographic Details
Published in:Journal of monetary economics 2009, Vol.56 (1), p.20-39
Main Authors: Primiceri, Giorgio E., van Rens, Thijs
Format: Article
Language:English
Subjects:
Consumer spending
Consumption
Consumption Inequality Risk Incomplete markets Heterogeneity
Economic models
Heterogeneity
Household expenditure
Income inequality
Incomplete markets
Inequality
Life cycles
Macroeconomics
Risk
Studies
U.S.A
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Summary:Was the increase in income inequality in the US due to permanent shocks or merely to an increase in the variance of transitory shocks? The implications for consumption and welfare depend crucially on the answer to this question. We use Consumer Expenditure Survey (CEX) repeated cross-section data on consumption and income to decompose idiosyncratic changes in income into predictable life-cycle changes, transitory and permanent shocks and estimate the contribution of each to total inequality. Our model fits the joint evolution of consumption and income inequality well and delivers two main results. First, we find that permanent changes in income explain all of the increase in inequality in the 1980s and 1990s. Second, we reconcile this finding with the fact that consumption inequality did not increase much over this period. Our results support the view that many permanent changes in income are predictable for consumers, even if they look unpredictable to the econometrician, consistent with models of heterogeneous income profiles.
ISSN:0304-3932
1873-1295
DOI:10.1016/j.jmoneco.2008.10.001