Wealth, Race, and Consumption Smoothing of Typical Income Shocks

85 Pages Posted: 23 Apr 2020

See all articles by Peter Ganong

Peter Ganong

University of Chicago; National Bureau of Economic Research (NBER)

Damon Jones

University of Chicago - Harris School of Public Policy

Pascal Noel

University of Chicago Booth School of Business

Diana Farrell

JP Morgan Chase & Co. - JP Morgan Chase Institute

Fiona Greig

JPMorgan Chase Institute

Chris Wheat

JP Morgan Chase & Co. - JP Morgan Chase Institute

Multiple version iconThere are 2 versions of this paper

Date Written: April 21, 2020

Abstract

We study the consumption response to typical labor income shocks and investigate how these vary by wealth and race. First, we estimate the elasticity of consumption with respect to income using an instrument based on firm-wide changes in monthly pay. While much of the consumption-smoothing literature uses variation in unusual windfall income, this instrument captures the income variation that households typically experience. In addition, because it can be constructed for every worker in every month, it allows for more precision than most previous estimates. We implement this approach in administrative bank account data and find an average elasticity of 0.23, with a standard error of 0.01. The increased precision also allows us to address an open question about the extent of heterogeneity by wealth in the elasticity. We find a much lower consumption response for high liquidity households, which may help discipline structural consumption models.

Second, we use this instrument to study how wealth shapes racial inequality. An extensive body of work documents a substantial racial and ethnic wealth gap. However, less is known about how this gap translates into differences in welfare on a month-to-month basis. We make progress on this question by combining our instrument for typical income volatility with a new dataset linking bank account data with race and Hispanicity. We find that black (Hispanic) households cut their consumption 50 (20) percent more than white households when faced with a similarly-sized income shock. Nearly all of this differential pass-through of income to consumption is explained in a statistical sense by differences in liquid wealth. Combining our empirical estimates with a model, we show that temporary income volatility has a substantial welfare cost for all groups. Because of racial disparities in consumption smoothing, the cost is at least 50 percent higher for black households and 20 percent higher for Hispanic households than it is for white households.

Suggested Citation

Ganong, Peter and Jones, Damon and Noel, Pascal and Farrell, Diana and Greig, Fiona and Wheat, Chris, Wealth, Race, and Consumption Smoothing of Typical Income Shocks (April 21, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-49, Available at SSRN: https://ssrn.com/abstract=3583707 or http://dx.doi.org/10.2139/ssrn.3583707

Peter Ganong (Contact Author)

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Damon Jones

University of Chicago - Harris School of Public Policy ( email )

1155 East 60th Street
Chicago, IL 60637
United States

Pascal Noel

University of Chicago Booth School of Business ( email )

Diana Farrell

JP Morgan Chase & Co. - JP Morgan Chase Institute ( email )

New York, NY
United States

Fiona Greig

JPMorgan Chase Institute ( email )

Washington, DC
United States

Chris Wheat

JP Morgan Chase & Co. - JP Morgan Chase Institute ( email )

New York, NY
United States

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