Heterogenous Consumption Responses and Wealth Inequality over the Business Cycle

Recent research has highlighted the importance of heterogeneity in the marginal propensity to consume (MPC) out of transitory income shocks for the efficacy of monetary and fiscal policy. However, work on estimating the distribution of MPCs remains scant and typically assumes that an individual’s MPC remains constant over time. Using the US Panel Study of Income Dynamics (PSID), I calibrate a model of microeconomic wealth and discount rate heterogeneity with aggregate shocks over the Great Recession of 2008, a historical ‘upper bound’ in terms of the dynamics of the wealth distribution in recessionary times. Using a reduced-form model, I estimate the degree of heterogeneity in MPCs both over the population and over the business cycle and show that a state-invariant MPC distribution is irreconcilable with empirical changes in the wealth distribution.