Does Income Inequality Lead to Consumption Inequality? Evidence and Theory1

Using data from the Consumer Expenditure Survey, we ...rst 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 di¤erent trends in within-group inequality, which has increased signi...cantly for income but little for consumption. We then develop a simple framework that allows us to analytically characterize how within-group income inequality a¤ects 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. keywords: Limited Enforcement, Risk Sharing, Consumption Inequality jel classification codes : E21, D91, D63, D31, G22 We thank the editor, Fabrizio Zilibotti, three anonymous referees, and seminar participants at numerous institutions and conferences for their many and very helpful comments. Many thanks also to Harris Dellas and Pierre-Olivier Gourinchas for their thoughtful discussions and to Carlos Serrano and Cristobal Huneeus for outstanding research assistance. Krueger gratefully acknowledges ...nancial support from the National Science Foundation under grant SES-0004376. 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.