Does Income Inequality Lead to Consumption Inequality?
asks Dirk Krueger and Fabrizio Perri:
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.
My thanks to the many comments following this post, which criticized a claim from John Hood:
Other evidence persuasively suggests that measuring household consumption, not income, is the best way to gauge living standards
One AB reader also pointed out Household Debt and Income Inequality, 1963-2003 by Matteo Iacoviello, which argues that the observed rise in household debt relative to income over the past 30 years is attributable to rising income inequality. Iacoviello’s model predicts that consumption inequality grows less than proportionally as income inequality grows, while wealth inequality grows more than proportionally.
Examining the distribution of current consumption misses the point that living standards should be gauged across individual’s lifetimes. While the very wealthy have ample resources for old age retirement, the evidence suggests that the working poor may not – unless we retain the Social Security Trust Fund as a vehicle to supplement their retirement benefits. Rightwingers like John Hood, however, are advocating that the government substantially reduce Social Security benefits. Go figure.