Permanent and transitory wage inequality of British men, 1975-2001: year, age and cohort effects
We examine the variance-covariance structure of log-wages over time and over the lifecycle of British men from 1975 to 2001, hereby controlling for cohort effects. Wage inequality has risen sharply during the 1980â€™s and early 1990â€™s and remained fairly constant in the second half of the 1990â€™s. We show that this increase is caused mainly by a strong increase in the transitory wage inequality and only to a lesser extent to an increase in the permanent wage inequality. The transitory component of wages is, however, highly persistent over time: serial correlation decreases from 0.88 over a one-year period to 0.65 over a ten-year period. The constant wage inequality in the second half of the 1990â€™s is attributed to a slight decrease in permanent wages inequality, a stabilization of the variance of the transitory wage shock, and the strong decrease in the transitory wage inequality for the cohorts entering employment since the end of the 1980â€™s. Ignoring age effects in transitory wage inequality and cohort effects, as is commonly done, leads to severely distorted inferences concerning the changes in permanent wage inequality.
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