Business Cycles and Household Formation: The Micro vs the Macro Labor Elasticity

We provide a new evidence on the cyclical behavior of the household size and lab or market outcomes of young people conditional on their living arrangements in the United States from 1979 to 2010. Household size is countercyclical, which is mostly driven by young people moving into or delaying departure from the parental home. We document that young people living with the old work and earn less, and their hours and wages are more volatile relative to their peers living alone. We argue that living arrangements induce larger disparities in the lab or market outcomes than age does. Motivated by these observations we provide a joint theory of household formation and labor market engagement including the business cycle. We lay down a theory where young individuals decide where to live depending on their relative wage rate, disutility of living with old and implicit transfers received from the old. We show differences in volatilities across age groups can be accounted for by incorporating household formation channel in to the real business cycle model, while restricting the labor elasticity of the old to be within the range measured by micro economists.