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Nonlinear Household Earnings Dynamics, Self-insurance, and Welfare

Author

Listed:
  • Mariacristina De Nardi
  • Giulio Fella
  • Gonzalo Paz Pardo

Abstract

Earnings dynamics are much richer than typically assumed in macro models with heterogeneous agents. This holds for individual-pre-tax and household-post-tax earnings and across administrative (Social Security Administration) and survey (Panel Study of Income Dynamics) data. We estimate two alternative processes for household after-tax earnings and study their implications using a standard life-cycle model. Both processes feature a persistent and a transitory component, but while the first one is the canonical linear process with stationary shocks, the second one has substantially richer earnings dynamics, allowing for age-dependence of moments, non-normality, and nonlinearity in previous earnings and age. Allowing for richer earnings dynamics implies a substantially better fit of the evolution of cross-sectional consumption inequality over the life cycle and of the individual-level degree of consumption insurance against persistent earnings shocks. The richer earnings process also implies lower welfare costs of earnings risk.

Suggested Citation

  • Mariacristina De Nardi & Giulio Fella & Gonzalo Paz Pardo, 2018. "Nonlinear Household Earnings Dynamics, Self-insurance, and Welfare," NBER Working Papers 24326, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:24326
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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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