Accounting for Patterns of Wealth Inequality

The life-cycle model is a standard theoretical framework for studying savings and wealth inequality. This paper shows that life-cycle models have difficulties accounting for the empirical relationship between lifetime earnings and household wealth. Quantitative life-cycle models imply a far tighter relationship between earnings and wealth than is observed in U.S. data. As a result, life-cycle models greatly overstate wealth differences between earnings rich and earnings poor households while at the same time underpredicting wealth inequality among households with similar lifetime earnings. Incorporating several features thought to be important for understanding wealth inequality, in particular bequests and entrepreneurship, does not improve the model's ability to account for the data. These findings suggest that standard life-cycle theory fails to account for an important source of wealth inequality.