Unequal Business Cycles (Job Market Paper)

Standard incomplete-markets (SIM) models predict that the consumption of low-skilled households is more cyclical relative to the consumption of high-skilled because they hold fewer liquid assets and experience larger income changes. I use the Consumer Expenditure Survey (CEX) to show that the opposite is true in the data: lower-skilled households experience smaller consumption changes over the business cycles. I also show that this difference in consumption cyclicality is explained by the fact that high-skilled households consume relatively more luxuries. Motivated by these facts, I extend the SIM model to allow for non-homothetic preferences over goods, which I discipline using cross-sectional data on how consumption shares of luxuries and necessities vary with income (Engel curves). The model reproduces the observation that consumption is more cyclical for high-skilled households because they spend a larger share of their income on luxuries, which are easier to substitute over time. The model also predicts that the welfare costs of recessions are larger for low-skilled households, despite their lower consumption declines.