Working Paper: NBER ID: w16327
Authors: Fatih Guvenen; Anthony Smith
Abstract: This paper uses the information contained in the joint dynamics of households' labor earnings and consumption-choice decisions to quantify the nature and amount of income risk that households face. We accomplish this task by estimating a structural consumption-savings model using data from the Panel Study of Income Dynamics and the Consumer Expenditure Survey. Specifically, we estimate the persistence of labor income shocks, the extent of systematic differences in income growth rates, the fraction of these systematic differences that households know when they begin their working lives, and the amount of measurement error in the data. Although data on labor earnings alone can shed light on some of these dimensions, to assess what households know about their income processes requires using the information contained in their economic choices (here, consumption-savings decisions). To estimate the consumption-savings model, we use indirect inference, a simulation method that puts virtually no restrictions on the structural model and allows the estimation of income processes from economic decisions with general specifications of utility, frequently binding borrowing constraints, and missing observations. The main substantive findings are that income shocks are not very persistent, systematic differences in income growth rates are large, and individuals have substantial amounts of information about their future income prospects. Consequently, the amount of uninsurable lifetime income risk that households perceive is substantially smaller than what is typically assumed in calibrated macroeconomic models with incomplete markets.
Keywords: Labor Income Risk; Indirect Inference; Consumption-Savings Model
JEL Codes: D12; D31; D52; E21; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Income shocks (D31) | Consumption choices (D10) |
| Perceived income risk (D81) | Consumption choices (D10) |
| Income growth rates (O49) | Systematic differences in income growth among individuals (D31) |
| Initial beliefs (D83) | Income growth rates (O49) |
| Information gathered over time (C80) | Initial beliefs (D83) |
| Uninsurable lifetime income risk perceived by individuals (G52) | Income risk in macroeconomic models (E19) |