Creator: Guvenen, Fatih and Smith, Anthony Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 485 Abstract:
This paper uses the information contained in the joint dynamics of individuals’ labor earnings and consumption-choice decisions to quantify both the amount of income risk that individuals face and the extent to which they have access to informal insurance against this risk. We accomplish this task by using indirect inference to estimate a structural consumption-savings model, in which individuals both learn about the nature of their income process and partly insure shocks via informal mechanisms. In this framework, we estimate (i) the degree of partial insurance, (ii) the extent of systematic differences in income growth rates, (iii) the precision with which individuals know their own income growth rates when they begin their working lives, (iv) the persistence of typical labor income shocks, (v) the tightness of borrowing constraints, and (vi) the amount of measurement error in the data. In implementing indirect inference, we find that an auxiliary model that approximates the true structural equations of the model (which are not estimable) works very well, with negligible small sample bias. The main substantive findings are that income shocks are not very persistent, systematic differences in income growth rates are large, individuals have substantial amounts of information about their income growth rates, and about one-half of income shocks are effectively smoothed via partial insurance. Putting these findings together, we argue that the amount of uninsurable lifetime income risk that individuals perceive is substantially smaller than what is typically assumed in calibrated macroeconomic models with incomplete markets.
Keyword: Labor income risk, Persistence , Heterogeneous income profiles, Idiosyncratic shocks, and Indirect Inference Estimation Subject (JEL): D81 - Criteria for Decision-Making under Risk and Uncertainty, D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, E21 - Macroeconomics: Consumption; Saving; Wealth, and C33 - Multiple or Simultaneous Equation Models: Panel Data Models; Spatio-temporal Models
Creator: Guvenen, Fatih, Ozkan, Serdar, and Song, Jae Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 476 Abstract:
This paper studies the nature of business cycle variation in individual earnings risk using a confidential dataset from the U.S. Social Security Administration, which contains (uncapped) earnings histories for millions of individuals. The base sample is a nationally representative panel containing 10 percent of all U.S. males from 1978 to 2010. We use these data to decompose individual earnings growth during recessions into “between-group” and “within-group” components. We begin with the behavior of within-group shocks. Contrary to past research, we do not find the variance of idiosyncratic earnings shocks to be countercyclical. Instead, it is the left-skewness of shocks that is strongly countercyclical. That is, during recessions, the upper end of the shock distribution collapses—large upward earnings movements become less likely—whereas the bottom end expands—large drops in earnings become more likely. Thus, while the dispersion of shocks does not increase, shocks become more left-skewed and, hence, risky during recessions. Second, to study between-group differences, we group individuals based on several observable characteristics at the time a recession hits. One of these characteristics—the average earnings of an individual at the beginning of a business cycle episode—proves to be an especially good predictor of fortunes during a recession: prime-age workers that enter a recession with high average earnings suffer substantially less compared with those who enter with low average earnings (which is not the case during expansions). Finally, we find that the cyclical nature of earnings risk is dramatically different for the top 1 percent compared with all other individuals—even relative to those in the top 2 to 5 percent.
Keyword: Idiosyncratic shocks, Administrative data, Countercyclical income risk, Skewness, and Factor structure Subject (JEL): J31 - Wage Level and Structure; Wage Differentials, E32 - Business Fluctuations; Cycles, J21 - Labor Force and Employment, Size, and Structure, and E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity