Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality

40 Pages Posted: 23 May 2008

See all articles by Giorgio E. Primiceri

Giorgio E. Primiceri

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Thijs van Rens

University of Warwick - Department of Economics; CEPR; Institute for the Study of Labor (IZA)

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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 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 90s. 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.

Keywords: consumption, inequality, risk, incomplete markets, heterogeneity

JEL Classification: D12, D31, D52, D91, E21

Suggested Citation

Primiceri, Giorgio E. and van Rens, Thijs, Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality. IZA Working Paper No. 3239, Available at SSRN: https://ssrn.com/abstract=1136401 or http://dx.doi.org/10.2139/ssrn.1136401

Giorgio E. Primiceri (Contact Author)

Northwestern University - Department of Economics ( email )

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HOME PAGE: http://faculty.econ.northwestern.edu/faculty/primiceri

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Thijs Van Rens

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom

HOME PAGE: http://www.thijsvanrens.com

Institute for the Study of Labor (IZA) ( email )

P.O. Box 7240
Bonn, D-53072
Germany

HOME PAGE: http://www.iza.org/profile?key=3806

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