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The Effects of Biased Labor Market Expectations on Consumption, Wealth Inequality, and Welfare

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Listed:
  • Almut Balleer
  • Georg Duernecker
  • Susanne K. Forstner
  • Johannes Goensch

Abstract

Idiosyncratic labor risk is a prevalent phenomenon with important implications for individual choices. In labor market research it is commonly assumed that agents have rational expectations and therefore correctly assess the risk they face in the labor market. We analyse survey data for the U.S. and document a substantial optimistic bias of households in their subjective expectations about future labor market transitions. Furthermore, we analyze the heterogeneity in the bias across different demographic groups and we find that high-school graduates tend to be strongly over-optimistic about their labor market prospects, whereas college graduates have rather precise beliefs. In the context of a quantitative heterogenous agents life cycle model we show that the optimistic bias has a quantitatively sizable negative effect on the life cycle allocation of income, consumption and wealth and implies a substantial loss in individual welfare compared to the allocation under full information. Moreover, we establish that the heterogeneity in the bias leads to pronounced differences in the accumulation of assets across individuals, and is thereby a quantitatively important driver of inequality in wealth.

Suggested Citation

  • Almut Balleer & Georg Duernecker & Susanne K. Forstner & Johannes Goensch, 2021. "The Effects of Biased Labor Market Expectations on Consumption, Wealth Inequality, and Welfare," CESifo Working Paper Series 9326, CESifo.
  • Handle: RePEc:ces:ceswps:_9326
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    Cited by:

    1. Almut Balleer & Georg Duernecker & Susanne Forstner & Johannes Goensch, 2023. "Wage Bargaining and Labor Market Policy with Biased Expectations," CESifo Working Paper Series 10341, CESifo.
    2. Jonathan J Adams & Eugenio Rojas, 2023. "Household Consumption and Dispersed Information," Working Papers 001009, University of Florida, Department of Economics.
    3. Almut Balleer & Georg Duernecker & Susanne Forstner & Johannes Goensch, 2023. "Biased Expectations and Labor Market Outcomes: Evidence from German Survey Data and Implications for the East-West Wage Gap," CESifo Working Paper Series 10336, CESifo.
    4. Jeanne Commault, 2022. "How Do Persistent Earnings Affect the Response of Consumption to Transitory Shocks?," Working Papers hal-03870685, HAL.
    5. Altmann, Steffen & Mahlstedt, Robert & Rattenborg, Malte Jacob & Sebald, Alexander, 2023. "Which Occupations Do Unemployed Workers Target? Insights from Online Job Search Profiles," IZA Discussion Papers 16696, Institute of Labor Economics (IZA).
    6. Jeanne Commault, 2022. "How Do Persistent Earnings Affect the Response of Consumption to Transitory Shocks?," SciencePo Working papers hal-03870685, HAL.
    7. Jeanne Commault, 2022. "How Do Persistent Earnings Affect the Response of Consumption to Transitory Shocks?," SciencePo Working papers Main hal-03870685, HAL.

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    More about this item

    Keywords

    subjective expectations; labor markets; consumption; asset accumulation; wealth inequality;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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