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Wage Risk and Employment Risk over the Life Cycle

  • Hamish Low
  • Costas Meghir
  • Luigi Pistaferri

We specify a structural life-cycle model of consumption, labour supply and job mobility in an economy with search frictions that allows us to distinguish between different sources of risk and to estimate their effects. The sources of risk are shocks to productivity, job destruction, the process of job arrival when employed and unemployed and match level heterogeneity. In contrast to simpler models that attribute all income fluctuations to shocks, our framework disentangles variability due to shocks from variability due to the responses to these shocks. Estimates of productivity risk, once we control for employment risk and for individual labour supply choices, are substantially lower than estimates that attribute all wage variation to productivity risk. Increases in productivity risk impose a considerable welfare loss on individuals and induce substantial precautionary saving. Increases in employment risk have large effects on output and, primarily through this channel, affect welfare. The welfare value of government p rogram s such as food stamps which partially insure productivity risk is greater than the value of unemployment insurance which provides (partial) insurance against employment risk and no insurance against persistent shocks.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14901.

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Date of creation: Apr 2009
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Publication status: published as Hamish Low & Costas Meghir & Luigi Pistaferri, 2010. "Wage Risk and Employment Risk over the Life Cycle," American Economic Review, American Economic Association, vol. 100(4), pages 1432-67, September.
Handle: RePEc:nbr:nberwo:14901
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