Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality

Abstract

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 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 …ts the joint evolution of consumption and income inequality well and delivers two main results. First, we …nd that permanent changes in income explain all of the increase in inequality in the 1980s and 90s. Second, we reconcile this …nding 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 pro…les.

Did Household Consumption Become More Volatile?

“…9 Battistin [2004], , and Battistin and Padula [2009] have documented that the gap between the Personal Consumption Expenditure and CES nondurable consumption data has been growing since 1990. 10 See for example, Baker [1997], Gottschalk [1997] Moffitt and Gottschalk [1994, Katz and Autor [1999], Blundell and Pistaferri [2003], Gyourko and Tracy [2003], Storesletten et al [2004], , Krueger and Perri [2006], , Davis and Kahn [2008], Gordon and Dew-Becker [2008], Keys [2008], Primiceri andvanRens [2009], Heathcote [2009]. 11 It is possible to come up with examples where inequality is rising in the society, but volatility is zero or unchanged, and vice versa.…”

Who Bears Aggregate Fluctuations and How?

“…One line of research has documented increases in income and consumption inequality over the past 25 years (e.g. David Cutler and Lawrence Katz (1991), Dirk Krueger and Fabrizio Perri (2003), Thomas Piketty and Emmanuel Saez (2003), Georgio E. Primiceri and Thijs van Rens (2008)). This work, typically framed within a basic permanent income model, focuses on the extent to which income shocks are insured and pays less attention to the extent to which insurance of aggregate shocks differs across households.…”

Income and Consumption Risk: Evidence from France

“…The model was applied to micro-data by BLUNDELL and PRESTON [1998] and extended by PRIMICERI and VAN RENS [2009]. In order to implement the decomposition between permanent and transitory shocks empirically, we characterize the reduced form stochastic process for (log) individual income for individual i in cohort k in period t as the sum of two components, a permanent and an transitory one:…”

“…To disentangle the three possibilities, we regress the log of the permanent shocks on age, cohort and time effects: 8 lnυ…”

“…More recent contributions have generalized their approach. GUVENEN [2007] introduced heterogeneity in the income profile, while PRIMICERI and VAN RENS [2009] added idiosyncratic shocks to income. Both studies conclude that it is important to take account of the non-concave consumption inequality profile.…”