Does Income Inequality Lead to Consumption Inequality? Evidence and Theory

45 Pages Posted: 12 Nov 2008

See all articles by Dirk Krueger

Dirk Krueger

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

Fabrizio Perri

Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: August 2002

Abstract

This paper first documents the evolution of the cross-sectional income and consumption distribution in the US in the past 25 years. Using data from the Consumer Expenditure Survey we find that a rising income inequality has not been accompanied by a corresponding rise in consumption inequality. Over the period from 1972 to 1998 the standard deviation of the log of after-tax labor income has increased by 20% while the standard deviation of log consumption has increased less than 2%. Furthermore income inequality has increased both between and within education groups while consumption inequality has increased between education groups but mildly declined within groups.We then argue that these empirical findings are consistent with the hypothesis that an increase in income volatility has been an important cause of the increase in income inequality, but at the same time has lead to an endogenous development of credit markets, allowing households to better smooth their consumption against idiosyncratic income fluctuations. We develop a consumption model in which the sharing of income risk is limited by imperfect enforcement of credit contracts and in which the development of financial markets depends on the volatility of the individual income process. This model is shown to be quantitatively consistent with the joint evolution of income and consumption inequality in US, while other commonly used consumption models are not.

Keywords: Limited Enforcement, Risk Sharing, Consumption Inequality

Suggested Citation

Krueger, Dirk and Perri, Fabrizio, Does Income Inequality Lead to Consumption Inequality? Evidence and Theory (August 2002). NYU Working Paper No. S-MF-02-07, Available at SSRN: https://ssrn.com/abstract=1300231

Dirk Krueger (Contact Author)

University of Pennsylvania - Department of Economics ( email )

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HOME PAGE: http://www.econ.upenn.edu/~dkrueger/

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Fabrizio Perri

Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-998-0251 (Phone)
212-995-4218 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~fperri/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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