Using data from the Consumer Expenditure Survey, we first document that the recent increase in income inequality in the United States has not been accompanied by a corresponding rise in consumption inequality. Much of this divergence is due to different trends in within-group inequality, which has increased significantly for income but little for consumption. We then develop a simple framework that allows us to analytically characterize how within-group income inequality affects consumption inequality in a world in which agents can trade a full set of contingent consumption claims, subject to endogenous constraints emanating from the limited enforcement of intertemporal contracts (as in Kehoe and Levine, 1993). Finally, we quantitatively evaluate, in the context of a calibrated general equilibrium production economy, whether this setup, or alternatively a standard incomplete markets model (as in Aiyagari, 1994), can account for the documented stylized consumption inequality facts from the U.S. data.

In this paper we reassess the evidence on labor income risk. There are two leading views on the nature of the income process in the current literature. The first view, which we call the Restricted Income Profiles(RIP) process, holds that individuals are subject to large and very persistent shocks, while facing similar life-cycle income pro-les. The alternative view, which we call the Heterogeneous Income Profiles(HIP) process, holds that individuals are subject to income shocks with modest persistence, while facing individual-specific income profiles. We first show that ignoring profile heterogeneity, when in fact it is present, introduces an upward bias into the estimates of persistence. Second, we estimate a parsimonious parameterization of the HIP process that is suitable for calibrating economic models. The estimated persistence is about 0.8 in the HIP process compared to about 0.99 in the RIP process. Moreover, the heterogeneity in income profiles is estimated to be substantial, explaining between 56 to 75 percent of income inequality at age 55. We also find that profile heterogeneity is substantially larger among higher educated individuals. Third, we discuss the source

This paper uses panel data on household consumption and income inquality to evaluate the degree of insurance to income shocks. Our aim is to describe the transmission of income inequality into consumption inequality. Our framework nests the special cases of self-insurance and the complete markets assumption. We assess the degree of insurance over and above selfinsurance through savings by contrasting shifts in the distribution of income growth with shifts in the distribution of consumption growth, and analyzing the way these two measures of household welfare correlate over time. We combine panel data on income from the PSID with consumption data from repeated CEX cross-sections using a demand analysis approach. Our results point to some partial insurance but reject the complete markets restriction. We Þnd a greater degree of insurance for transitory shocks and differences in the degree of insurance over time. We also document the importance of durables and of taxes and transfers as a means of insurance.

We define the distinction between productivity and employment risk and estimate the components of risk using wage and mobility data from the Panel Study of Income Dynamics. We then calibrate a model of intertemporal consumption and labor supply and study the effect of the two sources of risk on precautionary saving and labor supply. Finally, we measure the relative welfare costs of employment and productivity risk and the insurance contents of simple government programs.

Abstract This paper develops an analytical framework to study consumption and labor supply in heterogeneous-agent economies with partial insurance. The environment allows for insurance beyond non-contingent bonds, for permanent and transitory idiosyncratic productivity shocks, and for permanent preference heterogeneity and idiosyncratic preference shocks. Exact closed-form solutions are obtained for equilibrium allocations and for the first and second moments of the equilibrium joint distribution over wages, hours and consumption. With these expressions in hand, we show that all the structural preference and risk parameters in the model can be identified, even when productivity risk varies over time, given panel data on wages and hours, and cross-sectional data on consumption. We estimate the model on CEX and PSID data for the U.S. economy over the period . We then use the estimated parameter values to decompose inequality in all variables of interest, both over the life-cycle and across time, into cross-sectional variation in preferences, uninsurable wage risk, insurable wage risk, and measurement error.

Macroeconomics is evolving from the study of aggregate dynamics to the study of the dynam-ics of the entire equilibrium distribution of allocations across individual economic actors. This article reviews the quantitative macroeconomic literature that focuses on household hetero-geneity, with a special emphasis on the “standard ” incomplete markets model. We organize the vast literature according to three themes that are central to understanding how inequality matters for macroeconomics. First, what are the most important sources of individual risk and cross-sectional heterogeneity? Second, what are individuals ’ key channels of insurance? Third, how does idiosyncratic risk interact with aggregate risk? *This paper was prepared for Volume 1 of the Annual Review of Economics. Heathcote and Violante thank the National Science Foundation (Grant SES-0418029). The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. 1

This paper sheds light on the nature of labor income risk by exploiting the information contained in the joint dynamics of households’ labor earnings and consumption-choice decisions. In particular, this paper attempts to discriminate between two leading views on the nature of labor income risk: the “restricted income profiles” (RIP) model — in which individuals are subjected to large and persistent income shocks but face similar life-cycle income profiles — and the “heterogeneous income profiles” (HIP) model — in which individuals are subjected to income shocks with modest persistence but face individual-specific income profiles. Although these two diferent income processes have vastly di¤erent implications for economic behavior, earlier studies have found that labor income data alone is insufficient to distinguish between them. This paper, therefore, brings to bear the information embedded in consumption data. Specifically, we apply the powerful new tools of indirect inference to rich panel data on consumption and labor earnings to estimate a rich structural consumption-savings model. The method we develop is very flexible and allows the estimation of income processes from economic decisions in the presence of nonseparabilities between consumption and leisure, partial insurance of income shocks, frequently

This paper provides a critical survey of the large literature on the life cycle model of consumption, both from an empirical and a theoretical point of view. It discusses several approaches that have been taken in the literature to bring the model to the data, their empirical successes, and their failures. Finally, the paper reviews a number of changes to the standard life cycle model that could help solve the remaining empirical puzzles. 1.

In this paper we first document inequality trends in wages, hours worked, earnings, consumption, and wealth for Germany from the last twenty years. We generally find that inequality was relatively stable in West Germany until the German unification (which happened politically in 1990 and in our data in 1991), and then trended upwards for wages and market incomes, especially after about 1998. Disposable income and consumption, on the other hand, display only a modest increase in inequality over the same period. These trends occured against the backdrop of lower trend growth of earnings, incomes and consumption in the 1990s relative to the 1980s. In the second part of the paper we further analyze the differences between East and West Germans in terms of the evolution of levels and inequality of wages, income, and consumption.

Is lifetime inequality mainly due to differences across people established early in life or to differences in luck experienced over the working lifetime? We answer this question within a model that features idiosyncratic shocks to human capital, estimated directly from data, as well as heterogeneity in ability to learn, initial human capital, and initial wealth. We find that, as of age 23, differences in initial conditions account for more of the variation in lifetime earnings, lifetime wealth and lifetime utility than do differences in shocks received over the working lifetime.