Tuesday, February 17, 2009

Who bears the cost of fluctuations?

Now we are in a recession, who are those who will reduce their consumption the most? There are two obvious candidates: those who get unemployed and those were consuming a lot to start with. We know since the work of Jonathan Gruber, that consumption drops by 7% at the start of an unemployment spell despite unemployment insurance, and with a recession more people are unemployed. But, usually, those most likely to become unemployed in a recession are lower-skilled workers, who earn and consume less than average. A drop in aggregate consumption cannot be solely attributed to them.

Jonathan Parker and Annette Vissing-Jorgensen argue that those at the top of the consumption distribution suffer from very large fluctuations in consumption. Why would we care about the very rich? Because they influence aggregates and we seem to care about those. Also, this means that consumption inequality will be reduce considerably during this recession, even more than usual as the incomes of the very rich appear to be more affected than typically.

In their study, Parker and Vissing-Jorgensen find that the high correlation of individual and aggregate consumption of the very rich is a recent phenomenon. This is not due to the composition of their income, which is increasingly wage-based, as both individual capital and labor income are procyclical, and became more so recently. This should lay to rest the idea that rich households are able to smooth much better their consumption over the business cycle.

2 comments:

paimor said...

" This should lay to rest the idea that rich households are able to smooth much better their consumption over the business cycle. "

I do not understand the logic. I though that the common belief is that high income people have better access to financial instruments and education, and as such they get better insurance against their IDIOSYNCRATIC risk. Aggregate risk is undiversifiable to begin with.

Economic Logician said...

Correct, paimor. But it looks like their consumption fluctuates more that the aggregate.