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Idiosyncratic Labour Income Risk and Aggregate Consumption: an Unobserved Component Approach

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Author Info
Lorenzo Pozzi () (Erasmus University Rotterdam)
Abstract

We investigate the importance of aggregate and consumer-specific or idiosyncratic labour income risk for aggregate consumption changes in the US over the period 1952-2001. Theoretically, the effect of labour income risk on consumption changes is decomposed into an aggregate and into an idiosyncratic part. Empirically, aggregate risk is modelled through a GARCH process on aggregate labour income shocks and individual risk is modelled as an unobserved component and obtained through Kalman filtering. Our results suggest that aggregate labour income risk explains a negligible fraction of the variance of aggregate consumption changes. A more important part of aggregate consumption changes is explained by the unobserved component. The interpretation of this component as reflecting idiosyncratic labour income risk is supported by the finding that it is negatively affected by received consumer transfers. Idiosyncratic labour income risk thus matters for the aggregate economy.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 07-069/2.

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Date of creation: 12 Sep 2007
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Handle: RePEc:dgr:uvatin:20070069

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Related research
Keywords: Labour income uncertainty; consumption; precaution; state space models; GARCH errors; unobserved component; Bayesian;

Find related papers by JEL classification:
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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