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The Implications of Richer Earnings Dynamics for Consumption and Wealth

Listed author(s):
  • Mariacristina De Nardi
  • Giulio Fella
  • Gonzalo Paz Pardo

Earnings dynamics are much richer than those typically used in macro models with heterogenous agents. This paper provides multiple contributions. First, it proposes a simple non-parametric method to model rich earnings dynamics that is easy to estimate and introduce in structural models. Second, it applies our method to estimate a nonparametric earnings process using two data sets: the Panel Study of Income Dynamics and a large, synthetic, data set that matches the dynamics of the U.S. tax earnings. Third, it uses a life cycle model of consumption to compare the consumption and saving implications of our two estimated processes to those of a standard AR(1). We find that, unlike the standard AR(1) process, our estimated, richer earnings process generates an increase in consumption inequality over the life cycle that is consistent with the data and better fits the savings of the households at the bottom 60% of the wealth distribution.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 21917.

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Date of creation: Jan 2016
Handle: RePEc:nbr:nberwo:21917
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  1. Fatih Guvenen & Fatih Karahan & Serdar Ozkan & Jae Song, 2015. "What Do Data on Millions of U.S. Workers Reveal about Life-Cycle Earnings Risk?," NBER Working Papers 20913, National Bureau of Economic Research, Inc.
  2. Hansen, G D, 1993. "The Cyclical and Secular Behaviour of the Labour Input: Comparing Efficiency Units and Hours Worked," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(1), pages 71-80, Jan.-Marc.
  3. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-396, March.
  4. Blundell, Richard & Graber, Michael & Mogstad, Magne, 2015. "Labor income dynamics and the insurance from taxes, transfers, and the family," Journal of Public Economics, Elsevier, vol. 127(C), pages 58-73.
  5. Orazio P. Attanasio & Guglielmo Weber, 2010. "Consumption and Saving: Models of Intertemporal Allocation and Their Implications for Public Policy," Journal of Economic Literature, American Economic Association, vol. 48(3), pages 693-751, September.
  6. Orazio Attanasio & Luigi Pistaferri, 2014. "Consumption Inequality over the Last Half Century: Some Evidence Using the New PSID Consumption Measure," American Economic Review, American Economic Association, vol. 104(5), pages 122-126, May.
  7. Jonathan D. Fisher & David S. Johnson & Timothy M. Smeeding, 2013. "Measuring the Trends in Inequality of Individuals and Families: Income and Consumption," American Economic Review, American Economic Association, vol. 103(3), pages 184-188, May.
  8. 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.
  9. Rios-Rull, Jose-Victor & Kuhn, Moritz, 2016. "2013 Update on the U.S. Earnings, Income, and Wealth Distributional Facts: A View from Macroeconomics," Quarterly Review, Federal Reserve Bank of Minneapolis, issue April, pages 1-75.
  10. Michael Graber & Jeremy Lise, 2016. "Labor Market Frictions, Human Capital Accumulation, and Consumption Inequality," 2016 Meeting Papers 136, Society for Economic Dynamics.
  11. Geweke, John & Keane, Michael, 2000. "An empirical analysis of earnings dynamics among men in the PSID: 1968-1989," Journal of Econometrics, Elsevier, vol. 96(2), pages 293-356, June.
  12. Mark Aguiar & Mark Bils, 2015. "Has Consumption Inequality Mirrored Income Inequality?," American Economic Review, American Economic Association, vol. 105(9), pages 2725-2756, September.
  13. repec:wly:emetrp:v:85:y:2017:i::p:693-734 is not listed on IDEAS
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