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Earnings and consumption dynamics: a nonlinear panel data framework

Listed author(s):
  • Manuel Arellano

    ()

    (Institute for Fiscal Studies and CEMFI)

  • Richard Blundell

    ()

    (Institute for Fiscal Studies and IFS and UCL)

  • Stéphane Bonhomme

    ()

    (Institute for Fiscal Studies and University of Chicago)

We develop a new quantile-based panel data framework to study the nature of income persistence and the transmission of income shocks to consumption. Log-earnings are the sum of a general Markovian persistent component and a transitory innovation. The persistence of past shocks to earnings is allowed to vary according to the size and sign of the current shock. Consumption is modeled as an age-dependent nonlinear function of assets and the two earnings components. We establish the nonparametric identification of the nonlinear earnings process and the consumption policy rule. Exploiting the enhanced consumption and asset data in recent waves of the Panel Study of Income Dynamics, we find nonlinear persistence and conditional skewness to be key features of the earnings process. We show that the impact of earnings shocks varies substantially across earnings histories, and that this nonlinearity drives heterogeneous consumption responses. The transmission of shocks is found to vary systematically with assets.

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Paper provided by Centre for Microdata Methods and Practice, Institute for Fiscal Studies in its series CeMMAP working papers with number CWP53/15.

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Date of creation: 07 Sep 2015
Handle: RePEc:ifs:cemmap:53/15
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