Working Paper: CEPR ID: DP4296
Authors: Jonathan Heathcote; Kjetil Storesletten; Giovanni L. Violante
Abstract: This Paper explores the implications of the recent sharp rise in US wage inequality for welfare and the cross-sectional distributions of hours worked, consumption and earnings. From 1967 to 1996 cross-sectional dispersion of earnings increased more than wage dispersion, due to a rise in the correlation between wages and hours worked. Over the same period, inequality in hours worked remained roughly constant, and consumption inequality increased only modestly. Using data from the PSID, we decompose the observed rise in wage inequality into changes in the variance of permanent, persistent and transitory shocks. With this changing wage process as the only primitive, we show that a calibrated overlapping-generations model with incomplete markets can account for these trends in cross-sectional US data. We also investigate the welfare costs of the rise in wage in-equality: the ex-ante loss is equivalent to a 5% decline in lifetime income for the worst affected cohorts.
Keywords: Consumption Inequality; Labour Supply; Wage Inequality; Welfare
JEL Codes: D11; D31; D58; D91; E21; I32; J22; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in wage inequality (J31) | rise in annual earnings inequality (D31) |
| changes in the wage process (J31) | observed cross-sectional dynamics in consumption and hours worked (J29) |
| changes in wage dynamics (J31) | welfare costs (I30) |
| variance of transitory shocks increasing (C22) | labor supply tracking wages more closely (J39) |
| nature of wage shocks (J31) | consumption inequality (D31) |
| rise in annual earnings inequality (D31) | greater earnings inequality (D31) |
| wage shocks (J31) | consumption dynamics (E21) |