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Earnings, Consumption and Life Cycle Choices

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  • Meghir, Costas
  • Pistaferri, Luigi

Abstract

We discuss recent developments in the literature that studies how the dynamics of earnings and wages affect consumption choices over the life cycle. We start by analyzing the theoretical impact of income changes on consumption--highlighting the role of persistence, information, size and insurability of changes in economic resources. We next examine the empirical contributions, distinguishing between papers that use only income data and those that use both income and consumption data. The latter do this for two purposes. First, one can make explicit assumptions about the structure of credit and insurance markets and identify the income process or the information set of the individuals. Second, one can assume that the income process or the amount of information that consumers have are known and test the implications of the theory. In general there is an identification issue that has only recently being addressed with better data or better "experiments". We conclude with a discussion of the literature that endogenizes people's earnings and therefore change the nature of risk faced by households.

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This chapter was published in:

  • O. Ashenfelter & D. Card (ed.), 2011. "Handbook of Labor Economics," Handbook of Labor Economics, Elsevier, edition 1, volume 4, number 5.
    This item is provided by Elsevier in its series Handbook of Labor Economics with number 5-09.

    Handle: RePEc:eee:labchp:5-09

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    Web page: http://www.elsevier.com/wps/find/bookseriesdescription.cws_home/BS_HE/description

    Related research

    Keywords: Consumption; Risk; Income dynamics; Life cycle;

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    References

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    1. Orazio Attanasio & Nicola Pavoni, 2007. "Risk Sharing in Private Information Models with Asset Accumulation: Explaining the Excess Smoothness of Consumption," NBER Working Papers 12994, National Bureau of Economic Research, Inc.
    2. Lisa A. Cameron & Christopher Worswick, 2003. "The Labor Market as a Smoothing Device: Labor Supply Responses to Crop Loss," Review of Development Economics, Wiley Blackwell, vol. 7(2), pages 327-341, 05.
    3. Katja Kaufmann & Luigi Pistaferri, 2009. "Disentangling Insurance and Information in Intertemporal Consumption Choices," American Economic Review, American Economic Association, vol. 99(2), pages 387-92, May.
    4. Joseph G. Altonji & Ana Paula Martins & Aloysius Siow, 1987. "Dynamic Factor Models of Consumption, Hours, and Income," NBER Working Papers 2155, National Bureau of Economic Research, Inc.
    5. Erich Battistin, 2003. "Errors in survey reports of consumption expenditures," IFS Working Papers W03/07, Institute for Fiscal Studies.
    6. Mark Huggett & Gustavo Ventura & Amir Yaron, 2011. "Sources of Lifetime Inequality," American Economic Review, American Economic Association, vol. 101(7), pages 2923-54, December.
    7. Raj Chetty & Adam Szeidl, 2006. "Consumption Commitments and Risk Preferences," NBER Working Papers 12467, National Bureau of Economic Research, Inc.
    8. Flavio Cunha & James J. Heckman & Salvador Navarro, 2005. "Separating Uncertainty from Heterogeneity in Life Cycle Earnings," NBER Working Papers 11024, National Bureau of Economic Research, Inc.
    9. Primiceri, Giorgio E. & van Rens, Thijs, 2007. "Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality," IZA Discussion Papers 3239, Institute for the Study of Labor (IZA).
    10. Huggett, Mark, 1996. "Wealth distribution in life-cycle economies," Journal of Monetary Economics, Elsevier, vol. 38(3), pages 469-494, December.
    11. Melvin Stephens, 2008. "The Consumption Response to Predictable Changes in Discretionary Income: Evidence from the Repayment of Vehicle Loans," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 241-252, May.
    12. Yuriy Gorodnichenko & Klara Sabirianova Peter & Dmitriy Stolyarov, 2009. "Inequality and Volatility Moderation in Russia: Evidence from Micro-Level Panel Data on Consumption and Income," NBER Working Papers 15080, National Bureau of Economic Research, Inc.
    13. Fatih Guvenen, 2006. "Learning your earning: are labor income shocks really very persistent?," Discussion Paper / Institute for Empirical Macroeconomics 145, Federal Reserve Bank of Minneapolis.
    14. Luigi Guiso & Luigi Pistaferri & Fabiano Schivardi, 2002. "Insurance within the firm," 10th International Conference on Panel Data, Berlin, July 5-6, 2002 C3-1, International Conferences on Panel Data.
    15. Orazio Attanasio & Hamish Low & Virginia Sanchez-Marcos, 2008. "Explaining Changes in Female Labor Supply in a Life-Cycle Model," American Economic Review, American Economic Association, vol. 98(4), pages 1517-52, September.
    16. Fatih Guvenen, 2007. "An Empirical Investigation of Labor Income Processes," NBER Working Papers 13394, National Bureau of Economic Research, Inc.
    17. Erich Battistin & Richard Blundell & Arthur Lewbel, 2007. "Why is consumption more log normal than income? Gibrat's law revisited," IFS Working Papers W07/08, Institute for Fiscal Studies.
    18. Geweke, John & Keane, Michael, 2000. "An empirical analysis of earnings dynamics among men in the PSID: 1968-1989," Journal of Econometrics, Elsevier, vol. 96(2), pages 293-356, June.
    19. Dehejia, Rajeev & DeLeire, Thomas & Luttmer, Erzo F. P., 2005. "Insuring Consumption and Happiness through Religious Organizations," Working Paper Series rwp05-047, Harvard University, John F. Kennedy School of Government.
    20. Melvin Stephens, 2001. "The Long-Run Consumption Effects Of Earnings Shocks," The Review of Economics and Statistics, MIT Press, vol. 83(1), pages 28-36, February.
    21. Banks, James & Blundell, Richard & Brugiavini, Agar, 2001. "Risk Pooling, Precautionary Saving and Consumption Growth," Review of Economic Studies, Wiley Blackwell, vol. 68(4), pages 757-79, October.
    22. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
    23. Thomas, Duncan & Beegle, Kathleen & Frankenberg, Elizabeth & Sikoki, Bondan & Strauss, John & Teruel, Graciela, 2004. "Education in a crisis," Journal of Development Economics, Elsevier, vol. 74(1), pages 53-85, June.
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    Cited by:
    1. Mark Huggett & Gustavo Ventura & Amir Yaron, 2007. "Sources of Lifetime Inequality," NBER Working Papers 13224, National Bureau of Economic Research, Inc.
    2. Mark Huggett and Greg Kaplan, 2010. "Human Capital Values and Returns:Bounds Implied By Earnings and Asset Returns Data," Working Papers gueconwpa~10-10-02, Georgetown University, Department of Economics.
    3. Moritz Kuhn & Mark Wright & Tom Krebs, 2012. "Human Capital Risk, Contract Enforcement, and the Macroeconomy," 2012 Meeting Papers 159, Society for Economic Dynamics.
    4. Gustavsson, Magnus, 2013. "Permanent versus transitory wage differentials and the inequality-hours hypothesis," Economics Letters, Elsevier, vol. 121(3), pages 537-541.
    5. Mark Huggett & Greg Kaplan, 2012. "The Money Value of a Man," Working Papers 2012-009, Human Capital and Economic Opportunity Working Group.
    6. Stephen Jenkins & Peter Lambert, 2011. "Robert Moffitt and Peter Gottschalk’s 1995 paper ‘Trends in the covariance structure of earnings in the US: 1969–1987’," Journal of Economic Inequality, Springer, vol. 9(3), pages 433-437, September.

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