EconLog

Consumption vs. Income, 2002-11-07

Virginia Postrel points out that consumer spending is more stable than income.

There are really two different components of income inequality: permanent differences and temporary fluctuations. People tend to base their spending on what they expect their long-term prospects to be.

She points to a paper by Fabrizio Perri and Dirk Krueger.

It is our hypothesis that an increase in the volatility of idiosyncratic labor income has been an important cause of the increase in income inequality, but that it has also caused a change in the development of financial markets, allowing individual households to better insure against idiosyncratic income fluctuations.

In other words, for any individual, the gap between low-income years (think of a law school student) and high-income years (think of a successful lawyer) has widened. The economy has developed more sophisticated financial institutions for enabling people to borrow in their low-income years and to save in their high-income years.

Discussion Question. Other data show that the ratio of personal debt to GDP is near an all-time high. Do these new financial institutions make the economy less fragile with respect to a short recession, but more fragile if the recession deepens and persists?