Wealth, Race, and Consumption Smoothing of Typical Income Shocks

85 Pages Posted: 24 Jul 2020 Last revised: 14 Apr 2021

See all articles by Peter Ganong

Peter Ganong

University of Chicago; National Bureau of Economic Research (NBER)

Damon Jones

University of Chicago - Harris School of Public Policy

Pascal Noel

University of Chicago Booth School of Business

Fiona Greig

JPMorgan Chase Institute

Diana Farrell

JP Morgan Chase & Co. - JP Morgan Chase Institute

Chris Wheat

JP Morgan Chase & Co. - JP Morgan Chase Institute

Multiple version iconThere are 2 versions of this paper

Date Written: July 2020

Abstract

We estimate the elasticity of consumption with respect to income using an instrument based on firm-wide changes in pay. While much of the consumption-smoothing literature uses variation in unusual windfall income, this instrument captures the temporary income variation that households typically experience. Furthermore, this estimator is precise, allowing us to address an open question about how much the elasticity varies with wealth. We find a much lower consumption response for high-liquidity households, which may help discipline structural models. We then use this instrument to study how wealth shapes racial inequality. An extensive body of work documents a substantial racial wealth gap. However, less is known about how this gap translates into differences in welfare on a month-to-month basis. We find that black (Hispanic) households cut their consumption 50 (20) percent more than white households when faced with a similarly-sized income shock. Nearly all of this differential pass-through of income to consumption is explained, in a statistical sense, by differences in liquid wealth. Combining our empirical estimates with a model, we show that the welfare cost of income volatility is at least 50 percent higher for black households and 20 percent higher for Hispanic households than it is for white households.

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Suggested Citation

Ganong, Peter and Jones, Damon and Noel, Pascal and Greig, Fiona and Farrell, Diana and Wheat, Chris, Wealth, Race, and Consumption Smoothing of Typical Income Shocks (July 2020). NBER Working Paper No. w27552, Available at SSRN: https://ssrn.com/abstract=3658848

Peter Ganong (Contact Author)

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
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National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Damon Jones

University of Chicago - Harris School of Public Policy ( email )

1155 East 60th Street
Chicago, IL 60637
United States

Pascal Noel

University of Chicago Booth School of Business ( email )

Fiona Greig

JPMorgan Chase Institute ( email )

Washington, DC
United States

Diana Farrell

JP Morgan Chase & Co. - JP Morgan Chase Institute ( email )

New York, NY
United States

Chris Wheat

JP Morgan Chase & Co. - JP Morgan Chase Institute ( email )

New York, NY
United States

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