Estimating the marginal propensity to consume using the distributions of income, consumption, and wealth

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Jonathan Fisher, Research Scholar, Stanford Univeristy
David Johnson, Director, Panel Study of Income Dynamics, University of Michigan
Jonathan Latner, Postdoctoral Research Associate, University of Bamberg
Timothy Smeeding, Lee Rainwater Distinguished Professor of Public Affairs and Economics, University of Wisconsin-Madison
Jeffrey Thompson, Principal Economist, Microeconomic Surveys Section, Federal Reserve Board of Governors


Recent studies of economic inequality almost always separately examine income inequality, consumption and wealth inequality, and hence, these studies miss the important synergy between the three measures explicit in the life-cycle budget constraint. Stiglitz et al. (2009) states: “…the most pertinent measures of the distribution of material living standards are probably based on jointly considering the income, consumption, and wealth position of households or individuals.” This paper examines the relationship between the three resource measures, determines how changes in income and wealth affect changes in consumption, and examines whether these changes are more dramatic at higher or lower levels of wealth. Using the Panel Study of Income Dynamics (PSID) from 1999-2013, we examine the conjoint distributions of income, consumption, and wealth for the same individuals. Using this conjoint distribution, we estimate the Euler equation for how consumption changes with respect to changes in income. We find that the overall marginal propensity to consume (MPC) is 0.10. We also show that the MPC is lower at higher wealth quintiles; the MPC is 0.15 for the lowest quintile and 0.06 for the highest quintile. This suggests that low wealth households cannot smooth consumption as much as do other households and therefore they respond more to changes in income. Using this distribution of MPCs, we find that this yields a larger expenditure multiplier, meaning a transfer of wealth to low wealth households would result in an increase in growth by 4 percentage points.

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