Inequality and the Lifecycle1

This paper investigates the sources of cross-sectional di¤erences in consumption, labor supply, wealth and welfare over the lifecycle. I document the existence of rich and informative lifecycle patterns in the joint distribution of wages, hours, consumption and wealth. I then estimate a structural model of precautionary savings with endogenous labor supply and uninsurable wage risk in an attempt to assess the ability of the standard incomplete markets model to simultaneously account for the various dimensions of lifecycle inequality. I …nd that in many dimensions the model provides a coherent explanation. However, the combination of certain features of the data provides an inherent challenge for this class of models. Structural estimates of parameter values are obtained using Monte-Carlo Markov Chain techniques. These are then used to decompose inequality at di¤erent points in the lifecycle into di¤erences in preferences, di¤erences in initial wealth endowments, di¤erences in …xed labor productivity and the accumulated e¤ects of shocks realized after entry to the labor market. I …nd that around 40% of the cross-sectional di¤erences in lifetime welfare are due to …xed skills and around 60% are due to lifecycle productivity shocks. Di¤erences in …nancial wealth endowments, however, account for almost none of the inequality in lifetime welfare. JEL Classi…cation Codes: D31, E21,C13, J22 Keywords: Inequality, Lifecycle, Precautionary savings, Structural estimation, Monte-carlo Markov Chain, Labor supply. This is a revised version of an earlier draft circulated under the title "Idiosyncratic Income Risk and the Patterns of Lifecycle Inequality". Gianluca Violante has provided me with invaluable guidance at each stage of this project, for which I am extremely grateful. I have also bene…tted from useful discussions with Richard Blundell, Mark Dean, Matthias Kredler, Costas Meghir and Tom Sargent. Of course, all errors are my own.