Explaining Income Inequality and Intergenerational Mobility : The Role of Fertility and Family Transfers

How much of income inequality is due to initial opportunities relative to adult income risk? What factors determine intergenerational mobility? We study these questions with particular interest in the impact of two family choices: fertility and transfers. Fertility rates, which are higher for low-income than high-income families, are associated with differences in the level of resources available for children's education. To evaluate the quantitative importance of fertility and family transfers, we extend the standard heterogeneous agent life-cycle model with idiosyncratic income shocks and incomplete markets to allow for endogenous fertility, family transfers, and education. Initial conditions are defined as the agents' initial state variables, which are endogenously related to parental background. We find that initial conditions account for 51% of the variation in lifetime earnings. Moreover, fertility and parents-to-children transfers generate up to 40 and 62% of the intergenerational mobility, respectively