Earnings Inequality and Other Determinants of Wealth Inequality

Increasing income and wealth inequality has led to renewed interest in understanding and explaining wealth and income distributions, and in particular the recent growth in their top shares (Piketty, 2014). The literature has largely emphasized the role of earnings inequality in explaining wealth inequality. Indeed, Bewley-Aiyagari economies, which focus on precautionary savings as an optimal response to stochastic earnings, represent the most popular approach of introducing heterogeneity into a representative consumer framework to study the distribution of wealth (see Benhabib and Bisin, 2017, for a survey). However, models of earnings inequality and precautionary savings find it generally difficult to reproduce the thick righttail of the wealth distribution observed in the data. In particular, these models cannot reproduce wealth distributions with substantially thicker right-tails (larger top shares) than earnings distributions. But, while comparable estimates of the statistical properties of wealth and earnings distributions are available only for a few countries, they invariably show that thicker wealth tails are a critical and robust feature of data. Consider to-date estimates of the tail index, a measure of the rate of decay of the right-tail of a distribution and hence a measure which is inversely related to its thickness: Wealth and earnings indices are, respectively, 1.48− 1.55 and 2 in the U.S.; 1.63− 1.85 and 3 in Sweden; and