From Earnings Inequality to Consumption Inequality

Abstract

This paper studies the paths from inequality in earnings to inequality in household consumption. We show that careful study of the evolution of the variances and covariances of earnings and consumption within cohorts across time can identify permanent and transitory shocks. We present an application to the evolution of inequality in the United Kingdom. We extend previous results to recognise separate earnings of partners in couples.The path from inequality in hourly wages to inequality in household consumption and ultimately welfare is mediated by numerous household decisions. Consumption changes are in¯uenced by labour supply choices and by the availability of saving and transfers to buffer temporary and unexpected shocks and by the existence of formal or informal insurance arrangements. This paper argues that the simultaneous analysis of earnings and consumption data can add key insights to our understanding of the evolution of inequality. In particular, the simultaneous analysis of consumption and earning inequality can be helpful in: (i) decomposing shocks to earnings and wages into transitory and permanent components; (ii) determining which shocks individual households are able to smooth out and which they are not; (iii) differentiating responses to various components of earnings ± in particular, the effect of shocks to primary earners and spouse.The large increase in wage inequality during the 1980s and early 1990s (documented, for instance, by Katz and Murphy

The Macroeconomic Implications of Rising Wage Inequality in the United States

“…The early literature (Lillard and Willis 1978, MaCurdy 1982, Carrol 1992) assumed stationarity of the parameters, but since the documentation of the increase in U.S. wage inequality, several papers allowed for time variation (examples are Abowd and Card 1989, Gottschalk and Moffitt 1994, Haider 2001, Meghir and Pistaferri 2002 for the U.S.; Baker and Solon 1999 for Canada; Blundell and Preston 1998, Dickens 2000, and Attanasio et al 2002 for the U.K.). In Section 2.3 we compare our findings with the previous literature.…”

Consumption Inequality and Family Labor Supply

“…Most of the papers in this literature do not consider the joint consumption-labor supply choice (with some exceptions, Altonji 1986) and focus on the single earner case. We show how the labor elasticities of intertemporal substitution can be identi…ed allowing for non-separability with respect to consumption and the labor supply 3 More in detail, Attanasio et al (2008) introduce a model with a two earners'household. They do not explicitly model the labor supply decision of the household, but rather use Markov process for the evolution of the participation of the second earner.…”

Permanent and transitory wages of British men, 1975–2001: year, age and cohort effects

“…Storesletten et al (2004) show that a life cycle consumption model with precautionary saving can explain this empirical finding provided that the earnings process is highly persistent. 4 The descriptive evidence provided by Attanasio et al (2002) also suggests that at the same age younger birth cohorts face higher consumption inequality. Cohort effects in the earnings process may explain this last finding.…”

“…For instance, the empirical finding that both the income-age and the consumption-age profiles are hump shaped (Carroll and Summers, 1991) can also be explained with persistent wage shocks together with a precautionary savings motive (see, e.g., Attanasio et al, 1999). Moreover, using UK data both Deaton and Paxson (1993) and Attanasio et al (2002) have documented that within-cohort consumption inequality rises nonlinearly with age. Storesletten et al (2004) show that a life cycle consumption model with precautionary saving can explain this empirical finding provided that the earnings process is highly persistent.…”