IDEAS home Printed from https://ideas.repec.org/p/ifs/ifsewp/04-26.html
   My bibliography  Save this paper

Income risk and consumption inequality: a simulation study

Author

Listed:
  • Richard Blundell

    (Institute for Fiscal Studies and University College London)

  • Hamish Low

    (Institute for Fiscal Studies and University of Oxford & Nuffield College)

  • Ian Preston

    (Institute for Fiscal Studies and University College London)

Abstract

This paper assesses the accuracy of decomposing income risk into permanent and transitory components using income and consumption data. We develop a specific approximation to the optimal consumption growth rule and use Monte Carlo evidence to show that this approximation can provide a robust method for decomposing income risk. The availability of asset data enables the use of a more accurate approximation allowing for partial self-insurance against permanent shocks. We show that the use of data on median asset holdings corrects much of the error in the simple approximation which assumes no self-insurance against permanent shocks.

Suggested Citation

  • Richard Blundell & Hamish Low & Ian Preston, 2004. "Income risk and consumption inequality: a simulation study," IFS Working Papers W04/26, Institute for Fiscal Studies.
    • Handle: RePEc:ifs:ifsewp:04/26
    as

    Download full text from publisher

    File URL: http://www.ifs.org.uk/wps/wp0426.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Richard V. Burkhauser & John G. Poupore, 1997. "A Cross-National Comparison Of Permanent Inequality In The United States And Germany," The Review of Economics and Statistics, MIT Press, vol. 79(1), pages 10-17, February.
    2. Attanasio, Orazio & Davis, Steven J, 1996. "Relative Wage Movements and the Distribution of Consumption," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1227-1262, December.
    3. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-1157, December.
    4. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(3), pages 659-684.
    5. Moshe Buchinsky & Jennifer Hunt, 1999. "Wage Mobility In The United States," The Review of Economics and Statistics, MIT Press, vol. 81(3), pages 351-368, August.
    6. Altug, Sumru & Miller, Robert A, 1990. "Household Choices in Equilibrium," Econometrica, Econometric Society, vol. 58(3), pages 543-570, May.
    7. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
    8. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(1), pages 1-55.
    9. Richard Blundell & Ian Preston, 1998. "Consumption Inequality and Income Uncertainty," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(2), pages 603-640.
    10. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 928-956, October.
    11. Hall, Robert E & Mishkin, Frederic S, 1982. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," Econometrica, Econometric Society, vol. 50(2), pages 461-481, March.
    12. Deaton, Angus & Paxson, Christina, 1994. "Intertemporal Choice and Inequality," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 437-467, June.
    13. Richard Blundell & Luigi Pistaferri & Ian Preston, 2008. "Consumption Inequality and Partial Insurance," American Economic Review, American Economic Association, vol. 98(5), pages 1887-1921, December.
    14. Costas Meghir & Luigi Pistaferri, 2004. "Income Variance Dynamics and Heterogeneity," Econometrica, Econometric Society, vol. 72(1), pages 1-32, January.
    15. Perri, Fabrizio & Krueger, Dirk, 2002. "Does Income Inequality Lead to Consumption Inequality?," CEPR Discussion Papers 3583, C.E.P.R. Discussion Papers.
    16. Robert A. Moffitt & Peter Gottschalk, 2002. "Trends in the Transitory Variance of Earnings in the United States," Economic Journal, Royal Economic Society, vol. 112(478), pages 68-73, March.
    17. Abowd, John M & Card, David, 1989. "On the Covariance Structure of Earnings and Hours Changes," Econometrica, Econometric Society, vol. 57(2), pages 411-445, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Richard Blundell & Ben Etheridge, 2010. "Consumption, Income and Earnings Inequality in Britain," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 76-102, January.
    2. Cai, Shu & Park, Albert, 2016. "Permanent income and subjective well-being," Journal of Economic Behavior & Organization, Elsevier, vol. 130(C), pages 298-319.
    3. Theloudis, Alexandros, 2011. "From income and consumption inequality to economic welfare inequality: the role of labor supply," MPRA Paper 37517, University Library of Munich, Germany.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Richard Blundell & Hamish Low & Ian Preston, 2013. "Decomposing changes in income risk using consumption data," Quantitative Economics, Econometric Society, vol. 4(1), pages 1-37, March.
    2. Blundell, Richard & Preston, Ian & Pistaferri, Luigi, 2002. "Partial Insurance, Information, and Consumption Dynamics," CEPR Discussion Papers 3666, C.E.P.R. Discussion Papers.
    3. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2014. "Consumption and Labor Supply with Partial Insurance: An Analytical Framework," American Economic Review, American Economic Association, vol. 104(7), pages 2075-2126, July.
    4. Storesletten, Kjetil & Telmer, Christopher I. & Yaron, Amir, 2004. "Consumption and risk sharing over the life cycle," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 609-633, April.
    5. Storesletten, Kjetil & Violante, Giovanni & Heathcote, Jonathan, 2004. "The Cross-Sectional Implications of Rising Wage Inequality in the United States," CEPR Discussion Papers 4296, C.E.P.R. Discussion Papers.
    6. Greg Kaplan & Giovanni L. Violante, 2010. "How Much Consumption Insurance beyond Self-Insurance?," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(4), pages 53-87, October.
    7. Orazio Attanasio & Margherita Borella, 2006. "Stochastic Components of Individual Consumption: A Time Series Analysis of Grouped Data," NBER Working Papers 12456, National Bureau of Economic Research, Inc.
    8. Manuel Sanchez & Felix Wellschmied, 2020. "Modeling Life-Cycle Earnings Risk with Positive and Negative Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 103-126, July.
    9. Monteiro, Paulo Santos, 2008. "Testing Full Consumption Insurance in the Frequency Domain," Economic Research Papers 269910, University of Warwick - Department of Economics.
    10. Orazio P. Attanasio, 1998. "Consumption Demand," NBER Working Papers 6466, National Bureau of Economic Research, Inc.
    11. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2009. "Quantitative Macroeconomics with Heterogeneous Households," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 319-354, May.
    12. Orazio P. Attanasio & Guglielmo Weber, 2010. "Consumption and Saving: Models of Intertemporal Allocation and Their Implications for Public Policy," Journal of Economic Literature, American Economic Association, vol. 48(3), pages 693-751, September.
    13. Primiceri, Giorgio E. & van Rens, Thijs, 2009. "Heterogeneous life-cycle profiles, income risk and consumption inequality," Journal of Monetary Economics, Elsevier, vol. 56(1), pages 20-39, January.
    14. Crawley, Edmund & Theloudis, Alexandros, 2024. "Income Shocks and their Transmission into Consumption," Discussion Paper 2024-012, Tilburg University, Center for Economic Research.
    15. Stéphane Bonhomme & Jean-Marc Robin, 2009. "Assessing the Equalizing Force of Mobility Using Short Panels: France, 1990-2000," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 76(1), pages 63-92.
    16. Fatih Guvenen, 2007. "Learning Your Earning: Are Labor Income Shocks Really Very Persistent?," American Economic Review, American Economic Association, vol. 97(3), pages 687-712, June.
    17. Orazio P. Attanasio & Nicola Pavoni, 2011. "Risk Sharing in Private Information Models With Asset Accumulation: Explaining the Excess Smoothness of Consumption," Econometrica, Econometric Society, vol. 79(4), pages 1027-1068, July.
    18. Theloudis, Alexandros, 2021. "Consumption inequality across heterogeneous families," European Economic Review, Elsevier, vol. 136(C).
    19. Ivan Vidangos, 2009. "Household welfare, precautionary saving, and social insurance under multiple sources of risk," Finance and Economics Discussion Series 2009-14, Board of Governors of the Federal Reserve System (U.S.).
    20. Hamish Low & Costas Meghir & Luigi Pistaferri, 2010. "Wage Risk and Employment Risk over the Life Cycle," American Economic Review, American Economic Association, vol. 100(4), pages 1432-1467, September.

    More about this item

    Keywords

    income risk; inequality; approximation methods; con-;
    All these keywords.

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ifs:ifsewp:04/26. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Emma Hyman (email available below). General contact details of provider: https://edirc.repec.org/data/ifsssuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.