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RWP 21-17, December 2021

Wealth in the utility function (WIU) has been used recently in the literature and can be justified by a few theories, including Max Weber's (1904–05, German; 1958) theory on “spirit of capitalism.” We incorporate the WIU into a general equilibrium consumption-portfolio choice model to examine the effects on consumption inequality, equilibrium interest rate, and equity premium—an unexplored area in the literature. We provide closed-form solutions to help disentangle the effects of the WIU in driving the key results. Quantitatively, we show that a direct preference for wealth can improve the model’s predictions in all three dimensions (consumption inequality, equilibrium interest rate, and equity premium) simultaneously. We show our results are robust to more general specifications on the income process and to incorporating macroeconomic rare disasters. Finally, we compare the WIU with a closely related hypothesis, habit formation, and find that they have opposite effects on equilibrium asset returns and consumption inequality.

JEL classifications: C61, D81, E21

Article Citation

  • Luo, Yulei, Jun Nie, and Heng-fu Zou. 2021. “Wealth in the Utility Function and Consumption Inequality.” Federal Reserve Bank of Kansas City, Research Working Paper no. 21-17, December. Available at External Link