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Earnings and consumption dynamics: a nonlinear panel data framework

Author

Listed:
  • Manuel Arellano

    (Institute for Fiscal Studies and Centre for Monetary and Financial Studies (CEMFI))

  • Richard Blundell

    (Institute for Fiscal Studies and University College London)

  • Stéphane Bonhomme

    (Institute for Fiscal Studies and University of Chicago)

Abstract

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.

Suggested Citation

  • Manuel Arellano & Richard Blundell & Stéphane Bonhomme, 2015. "Earnings and consumption dynamics: a nonlinear panel data framework," IFS Working Papers W15/24, Institute for Fiscal Studies.
    • Handle: RePEc:ifs:ifsewp:15/24
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    More about this item

    Keywords

    Earnings dynamics; consumption; panel data; quantile regression; latent variables.;
    All these keywords.

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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