Understanding the distributional effects of income uncertainty shocks

Abstract

This paper studies how uncertainty shocks shape consumption distribution in a quantitative model with heterogeneous agents and endogenous economic uncertainty. Our findings suggest that the measure of consumption inequality rises to an income uncertainty shock. This is primarily attributed to the heterogeneous liquidity demand elasticity on uncertainty across households. More specifically, the elasticity is higher for those from low-income families. Therefore, the consumption of households with low disposable income levels appears to be more adversely affected by uncertainty shocks relative to those with high disposable income. Besides, this paper highlights that the distributional effect amplifies the adverse impact of uncertainty on consumption. The policy analysis suggests that increasing the supply of liquid assets can effectively stimulate demand and reduce consumption inequality in response to uncertainty shocks.