Race, the Wealth Gap, and Income Shocks

How do different types of households respond to economic volatility?

A new study conducted by researchers at the University of Chicago Harris School of Public Policy shows that income shocks–that is, sudden but temporary reductions in income–affect Black and Hispanic households more strongly than their white counterparts as a result of the persistent racial and ethnic wealth gap in the U.S.

Using a dataset linking bank account data with voter registration records containing race and ethnicity, Associate Professor Damon Jones, Assistant Professor Peter Ganong, and coauthors were able to examine, with unprecedented levels of specificity, the spending behaviors of households, and to examine how self-reported Black, Hispanic, and white households behave differently when faced with sudden income reductions.

The Black and Hispanic households represented in the study appear to be less able engage in “consumption smoothing” to maintain their lifestyle habits when faced with a sudden reduction of income. Economists use the term “consumption smoothing” to describe the behavior of an individual or a household to balance spending and saving so that their standard of living, as measured by consumption, can stay consistent in times when income is volatile.

“On average, in comparison to white households, Hispanic households responded to income shocks with a twenty percent greater reduction in consumption while Black households responded with a fifty percent greater reduction,” said Ganong. “This is a significant finding for policymakers to consider as the economic crisis unfolds, particularly in light of how to date it has disproportionately affected minority racial and ethnic communities.”

The researchers find further that the larger effects of income disruptions on Black and Hispanic households are likely explained by the ethnic and racial wealth gap (the difference in accumulated assets) between white and non-white households. Black and Hispanic households, on the whole, do behave differently than white households, the researchers conclude, but, when controlled for wealth, as estimated through liquid assets, households in similar financial situations react in similar ways to income shocks, regardless of race.

In other words, Jones explained, “Race and ethnicity are significant predictors of the degree to which households cut spending in response to income shocks, and the differences in wealth between these groups appear to be an important factor in driving these differences.”

The research also explores the effect of income shocks on household welfare as calculated by a combination of consumption and income. The study finds that eliminating the shock would result in a welfare gain that is 46 to 56 percent higher for Black households and 22 to 32 percent higher for Hispanic households in comparison to white households. These findings diverge from previous literature that assumes the effect of income shocks on welfare to be zero. 

This study focuses on the typical income shocks that may be caused by temporarily reduced hours, seasonal variation or other typical variations that affect wage-earners, and helps to shed light on how the wealth gap affects short-term month to month financial behavior.

“These findings have important implications for any policy that aims to mitigate the impact of income volatility and to reduce economic inequality between racial and ethnic groups,” Ganong and Jones emphasized.

The study is part of a broader research effort conducted in partnership with the JPMorgan Chase Institute, which explores racial gaps in financial outcomes.