A quantitative evaluation of earnings risk and wealth inequality in the U.K.

This thesis studies inequality in several dimensions, with an emphasis on the analysis of inequality within and between groups (including by social class, occupation and education). It aims to identify factors that affect inequality and how income and wealth are distributed within society. In the first chapter, we examine the distributional effects of savings externalities. Incomplete markets models imply heterogeneous household savings behaviour which in turn generates pecuniary externalities via the interest rate. Conditional on differences in the processes determining household earnings for distinct groups in the population, these savings externalities may contribute to inequality. Working with an open economy heterogenous agent model, where the interest rate only partially responds to domestic asset supply, we find that differences in the earnings processes of British households with university and non-university educated heads entail savings externalities that increase wealth inequality between the groups and within the group of the non-university educated households. We further find that while the inefficiency effects of these externalities are quantitatively small, the distributional effects are sizeable. In the second chapter we examine the distributional effects of social pressure. In particular, we develop a theoretical framework where the cross-sectional distributions of hours, earnings, wealth and consumption are determined jointly with a set of expenditure targets defining peer and aspirational pressure for members of different social classes. We show existence of a stationary socio-economic equilibrium, under stochastic productivity and socio-professional class participation. We calibrate a model belonging to this framework using British data and find that it captures the main patterns of inequality, between and within the social groupings. We discover a complex pattern of how peer and aspirational pressure affects within- and cross-group inequality depending on both group membership and the inequality measure considered. A principal finding is that wealth and consumption inequality increase within groups who aspire to match social targets from a higher class, despite a reduction in within-group inequality in hours and earnings. Such aspirations can thus lead to social frustration, associated with increases in the dispersion of economic outcomes, and hence in the magnitude and likelihood of underachievement in meeting consumption targets. The third chapter seek to characterise the nature and cyclicality of household income risk in Great Britain. This chapter establishes new evidence on the cyclical behaviour of household income risk in Great Britain and assesses the role of social insurance policy in mitigating against this risk. We address these issues using the British Household Panel Survey (1991-2008) by decomposing stochastic idiosyncratic income into its transitory, persistent and fixed components. We then estimate how income risk, measured by the variance and the skewness of the probability distribution of shocks to the persistent component, varies between expansions and contractions of the aggregate economy. We first find that the volatility and left-skewness of these shocks is a-cyclical and counter-cyclical respectively. The latter implies a higher probability of receiving large negative income shocks in contractions. We also find that while social insurance (tax-benefits) policy reduces the levels of both measures of risk as well as the counter-cyclicality of the asymmetry measure, the mitigation effects work mainly via benefits