Working Paper: NBER ID: w24326
Authors: Mariacristina De Nardi; Giulio Fella; Gonzalo Paz Pardo
Abstract: Earnings dynamics are much richer than typically assumed in macro models with heterogeneous agents. This holds for individual-pre-tax and household-post-tax earnings and across administrative (Social Security Administration) and survey (Panel Study of Income Dynamics) data. We estimate two alternative processes for household after-tax earnings and study their implications using a standard life-cycle model. Both processes feature a persistent and a transitory component, but while the first one is the canonical linear process with stationary shocks, the second one has substantially richer earnings dynamics, allowing for age-dependence of moments, non-normality, and nonlinearity in previous earnings and age. Allowing for richer earnings dynamics implies a substantially better fit of the evolution of cross-sectional consumption inequality over the life cycle and of the individual-level degree of consumption insurance against persistent earnings shocks. The richer earnings process also implies lower welfare costs of earnings risk.
Keywords: Earnings Dynamics; Consumption Inequality; Welfare Costs
JEL Codes: E21; H21; J3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| richer earnings dynamics (J31) | consumption (E21) |
| richer earnings dynamics (J31) | wealth (D14) |
| richer earnings dynamics (J31) | welfare (I38) |
| richer earnings process (D33) | consumption pass-through of persistent earnings shocks (E21) |
| richer earnings process (D33) | welfare costs of earnings risk (J32) |
| richer earnings dynamics (J31) | consumption inequality (D31) |