Using the Chinese urban household survey data between 1997 and 2006, we find
that income inequality has a negative (positive) impact on households’ consumption
(savings), even after we control for family income. We argue that people save to
improve their social status when social status is associated with pecuniary and
non-pecuniary benefits. Rising income inequality can strengthen the incentives of
status-seeking savings by increasing the benefit of improving status and enlarging the
wealth level that is required for status upgrading. We also find that the negative effect
of income inequality on consumption is stronger for poorer and younger people, and
income inequality stimulates more education investment, which are consistent with the
status seeking hypothesis.