Issues in Political Economy, Vol 21, 2012, 31-45 Is Consumption in the United States Influenced by Income Inequality? A Cointegration Analysis

The effect of inequality of the distribution of income on aggregate consumption has been the subject of considerable debate over decades, especially between the Keynesian economists and the Chicago school economists. In the case of the United States, while income distribution has become more unequal since the 1970s, the country‟s aggregate consumption growth has been maintained at a relatively high rate. However, Keynesian economists like Palley (2002) and Setterfield (2010) argue that the fast growth of aggregate consumption in the United States can be attributed to an unsustainable process of debt financing. If the impact of debt financing is removed, the relationship between consumption and income inequality will become obvious. This paper examines the validity of this argument from a cointegration approach. The empirical analysis is based on a modified consumption function that includes the Gini Index and debtincome ratio, in addition to disposable income and a measure of wealth. A vector errorcorrection (VEC) model is constructed to determine the long-run relationship between income inequality and consumption in the United States. It is found that there exists a cointegrating relationship between the Gini Index and consumption. However, the regression results of the VEC model imply that income distribution only affects consumption in the short run.