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Relative Wage Movements and the Distribution of Consumption

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  • Orazio Attanasio
  • Steven J. Davis

Abstract

We analyze how relative wage movements across birth cohorts and education groups during the 1980s affected the distribution of household consumption. The analysis integrates the labor economics literature on time variation in the wage structure with the consumption insurance literature. In contrast to previous tests of consumption insurance, we examine the impact of systematic, publicly observable shifts in the hourly wage structure. To circumvent the extreme scarcity of longitudinal data with high quality information on both consumption and labor market outcomes, we draw upon the best available cross-sectional data sources to construct synthetic panel data on consumption, labor supply and wages. We find that low-frequency movements in the cohort-education structure of pre-tax hourly wages drove large changes in the distribution of household consumption. The results constitute a spectacular failure of the consumption insurance hypothesis, and one that is not explained by existing theories of informationally constrained optimal consumption allocations. We also develop a procedure for assessing the welfare consequences of deviations from full consumption insurance and, in particular, from the failure to insulate the consumption distribution from relative wage shifts across cohort-education groups. For a coefficient of relative risk aversion equal to two, fully insulating households from group-specific endowment variation would raise welfare by an amount equivalent to a uniform 2.7% consumption increase.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4771.

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Date of creation: Jun 1994
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Publication status: published as Journal of Political Economy, December 1996, vol.104, no.6, pp.1227-1262.
Handle: RePEc:nbr:nberwo:4771

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  1. Phelan, Christopher & Townsend, Robert M, 1991. "Computing Multi-period, Information-Constrained Optima," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(5), pages 853-81, October.
  2. Townsend, Robert M., 1988. "Information constrained insurance : The revelation principle extended," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(2-3), pages 411-450.
  3. Townsend, Robert M, 1994. "Risk and Insurance in Village India," Econometrica, Econometric Society, Econometric Society, vol. 62(3), pages 539-91, May.
  4. Goldin, Claudia & Margo, Robert A, 1992. "The Great Compression: The Wage Structure in the United States at Mid-century," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 107(1), pages 1-34, February.
  5. Chinhui Juhn & Kevin M. Murphy & Robert H. Topel, 1991. "Why Has the Natural Rate of Unemployment Increased over Time?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(2), pages 75-142.
  6. David M. Cutler & Lawrence F. Katz, 1991. "Macroeconomic Performance and the Disadvantaged," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(2), pages 1-74.
  7. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
  8. Nelson, J.A., 1993. "On Testing for Full Insurance Using Consumer Expenditures Survey Data," Papers, California Davis - Institute of Governmental Affairs 93-02, California Davis - Institute of Governmental Affairs.
  9. Levy, Frank & Murnane, Richard J, 1992. "U.S. Earnings Levels and Earnings Inequality: A Review of Recent Trends and Proposed Explanations," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 30(3), pages 1333-81, September.
  10. Steven J. Davis, 1992. "Cross-Country Patterns of Change in Relative Wages," NBER Working Papers 4085, National Bureau of Economic Research, Inc.
  11. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(5), pages 957-76, October.
  12. Pencavel, John, 1987. "Labor supply of men: A survey," Handbook of Labor Economics, Elsevier, in: O. Ashenfelter & R. Layard (ed.), Handbook of Labor Economics, edition 1, volume 1, chapter 1, pages 3-102 Elsevier.
  13. Attanasio, Orazio P., 1999. "Consumption," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 11, pages 741-812 Elsevier.
  14. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(5), pages 928-56, October.
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