Skip to content Skip to navigation

Permanent Income Shocks, Target Wealth, and the Wealth Gap

Aug 2020
Working Paper
By  Tullio Jappelli, Luigi Pistaferri

We test the key implication of the buffer stock model, namely that any revision in permanent income leads to a proportionate revision in target wealth. We use panel data on the amount of wealth held for precautionary purposes available in the 2002-2016 SHIW. Using an instrumental variable approach to overcome measurement error issues and direct estimates of the permanent component of income, we find that households indeed revise approximately one-for-one their target wealth in response to permanent income shocks. We explore heterogeneity of the response across the cash-on-hand distribution, for positive and negative shocks, and for shocks of different size. We also find that the change in the ratio of cash-on-hand to permanent income is negatively correlated with the “wealth gap”, particularly for individuals whose wealth is substantially above target.