Creator: Yang, Fang Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 635 Abstract:
Micro data over the life cycle shows two different patterns of consumption of housing and non-housing goods: the consumption profile of non-housing goods is hump-shaped while the consumption profile for housing first increases monotonically and then flattens out. These patterns hold true at each consumption quartile. This paper develops a quantitative, dynamic general equilibrium model of life cycle behavior, which generates consumption profiles consistent with the observed data. Borrowing constraints are essential in explaining the accumulation of housing assets early in life, while transaction costs are crucial in generating the slow downsizing of the housing assets later in life. The bequest motives play a role in determining total life time wealth, but not the housing profile.
Keyword: Life cycle, Housing, Consumption, and Distribution Subject (JEL): J14 - Economics of the Elderly; Economics of the Handicapped; Non-labor Market Discrimination, E21 - Macroeconomics: Consumption; Saving; Wealth, and R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics: Housing Demand
Creator: Schulhofer-Wohl, Sam Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 707 Abstract:
A standard approach to estimating structural parameters in life-cycle models imposes sufficient assumptions on the data to identify the "age profile" of outcomes, then chooses model parameters so that the model's age profile matches this empirical age profile. I show that this approach is both incorrect and unnecessary: incorrect, because it generally produces inconsistent estimators of the structural parameters, and unnecessary, because consistent estimators can be obtained under weaker assumptions. I derive an estimation method that avoids the problems of the standard approach. I illustrate the method's benefits analytically in a simple model of consumption inequality and numerically by reestimating the classic life-cycle consumption model of Gourinchas and Parker (2002).
Keyword: Age-time-cohort identification problem and Life-cycle models Subject (JEL): J10 - Demographic Economics: General, C23 - Single Equation Models; Single Variables: Panel Data Models; Spatio-temporal Models, and D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
Creator: Guvenen, Fatih, Karahan, Fatih, Ozkan, Serdar, and Song, Jae Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 719 Abstract:
We study the evolution of individual labor earnings over the life cycle using a large panel data set of earnings histories drawn from U.S. administrative records. Using fully nonparametric methods, our analysis reaches two broad conclusions. First, earnings shocks display substantial deviations from lognormality–the standard assumption in the incomplete markets literature. In particular, earnings shocks display strong negative skewness and extremely high kurtosis–as high as 30 compared with 3 for a Gaussian distribution. The high kurtosis implies that in a given year, most individuals experience very small earnings shocks, and a small but non-negligible number experience very large shocks. Second, these statistical properties vary significantly both over the life cycle and with the earnings level of individuals. We also estimate impulse response functions of earnings shocks and find important asymmetries: positive shocks to high-income individuals are quite transitory, whereas negative shocks are very persistent; the opposite is true for low-income individuals. Finally, we use these rich sets of moments to estimate econometric processes with increasing generality to capture these salient features of earnings dynamics.
Keyword: Non-Guassian shocks, Skewness, Earnings dynamics, Kurtosis, Nonparametric estimation, Life-cycle earnings risk, and Normal mixture Subject (JEL): J24 - Human Capital; Skills; Occupational Choice; Labor Productivity, E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity, and J31 - Wage Level and Structure; Wage Differentials
Creator: Koijen, Ralph S. J., Nieuwerburgh, Stijn van, and Yogo, Motohiro Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 499 Abstract:
We develop a pair of risk measures, health and mortality delta, for the universe of life and health insurance products. A life-cycle model of insurance choice simplifies to replicating the optimal health and mortality delta through a portfolio of insurance products. We estimate the model to explain the observed variation in health and mortality delta implied by the ownership of life insurance, annuities including private pensions, and long-term care insurance in the Health and Retirement Study. For the median household aged 51 to 57, the lifetime welfare cost of market incompleteness and suboptimal choice is 3.2% of total wealth.
Keyword: Health insurance, Portfolio choice, Life insurance, Life-cycle model, and Annuities Subject (JEL): G11 - Portfolio Choice; Investment Decisions, D14 - Household Saving; Personal Finance, I13 - Health Insurance, Public and Private, and D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
Creator: Mehra, Rajnish, Piguillem, Facundo, and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 405 Abstract:
The difference between average borrowing and lending rates in the United States is over 2 percent. In spite of this large difference, there is over 1.7 times GNP in 2007 of intermediated borrowing and lending between households. In this paper a model is developed consistent with these facts. The only difference within an age cohort is preferences for bequests. Individuals with little or no bequest motive are lenders, while individuals with strong bequest motive are borrowers and owners of productive capital. Given no aggregate uncertainty, the return on equity is the same as the household borrowing rate. The government can borrow at the household lending rate, so there is a 2 percent equity premium in our world with no aggregate uncertainty. We examine the distribution and life cycle patterns of asset holding and consumption and find there is large dispersion in asset holdings and little in consumption.
This paper was subsequently published as Working Paper 685 under the title "Costly Financial Intermediation in Neoclassical Growth Theory."
Keyword: General equilibrium, Bequests, Life cycle, Asset returns, and Assets quantities Subject (JEL): G10 - General Financial Markets: General (includes Measurement and Data), E44 - Financial Markets and the Macroeconomy, and E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data)
Creator: Azariadis, Costas, Bullard, James, and Ohanian, Lee E. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 255 Abstract:
Autoregressions of quarterly or annual aggregate time series provide evidence of trend-reverting output growth and of short-term dynamic adjustment that appears to be governed by complex eigenvalues. This finding is at odds with the predictions of reasonably parameterized, convex one-sector growth models, most of which have positive real characteristic roots. We study a class of one-sector economies, overlapping generations with finite life spans of L greater than or equal to 3, in which aggregate saving depends nontrivially on the distribution of wealth among cohorts. If consumption goods are weak gross substitutes near the steady state price vector, we prove that the unique equilibrium of a life cycle exchange economy converges to the unique steady state via damped oscillations. We also conjecture that this form of trend reversion extends to production economies with a relatively flat factor-price frontier, and we test this conjecture in several plausible parameterizations of 55-period life cycle economies.
Keyword: Eigenvalues, Life cycle, Cyclical fluctuations, and Economies Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data)
Creator: Heathcote, Jonathan, Storesletten, Kjetil, and Violante, Giovanni L. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 551 Abstract:
This paper studies optimal taxation of earnings when the degree of tax progressivity is allowed to vary with age. The setting is an overlapping-generations model that incorporates irreversible skill investment, flexible labor supply, ex-ante heterogeneity in the disutility of work and the cost of skill acquisition, partially insurable wage risk, and a life cycle productivity profile. An analytically tractable version of the model without intertemporal trade is used to characterize and quantify the salient trade-offs in tax design. The key results are that progressivity should be U-shaped in age and that the average marginal tax rate should be increasing and concave in age. These findings are confirmed in a version of the model with borrowing and saving that we solve numerically.
Keyword: Labor supply, Skill investment, Life cycle, Tax progressivity, Incomplete markets, and Income distribution Subject (JEL): D30 - Distribution: General, E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), H40 - Publicly Provided Goods: General, J22 - Time Allocation and Labor Supply, H20 - Taxation, Subsidies, and Revenue: General, and J24 - Human Capital; Skills; Occupational Choice; Labor Productivity
Creator: Mehra, Rajnish, Piguillem, Facundo, and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 655 Abstract:
There is a large amount of intermediated borrowing and lending between households. Some of it is intergenerational, but most is between older households. The average difference in borrowing and lending rates is over 2 percent. In this paper, we develop a model economy that displays these facts and matches not only the returns on assets but also their quantities. The heterogeneity giving rise to borrowing and lending and differences in equity holdings depends on differences in the strength of the bequest motive. In equilibrium, the lenders are annuity holders and the borrowers are those who have equity holdings, who live off its income when retired, and who leave a bequest. The borrowing rate and return on equity are the same in the absence of aggregate uncertainty. The divergence between borrowing and lending rates can thus give rise to an equity premium, even in a world without aggregate uncertainty.
Keyword: Retirement, Equity premium, Government debt, Borrowing, Aggregate intermediation, Life cycle savings, and Lending Subject (JEL): H62 - National Deficit; Surplus, G23 - Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors, G11 - Portfolio Choice; Investment Decisions, D31 - Personal Income, Wealth, and Their Distributions, E21 - Macroeconomics: Consumption; Saving; Wealth, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), E44 - Financial Markets and the Macroeconomy, H00 - Public Economics: General, and G10 - General Financial Markets: General (includes Measurement and Data)
Creator: Heathcote, Jonathan, Perri, Fabrizio, and Violante, Giovanni L. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 436 Abstract:
We conduct a systematic empirical study of cross-sectional inequality in the United States, integrating data from the Current Population Survey, the Panel Study of Income Dynamics, the Consumer Expenditure Survey, and the Survey of Consumer Finances. In order to understand how different dimensions of inequality are related via choices, markets, and institutions, we follow the mapping suggested by the household budget constraint from individual wages to individual earnings, to household earnings, to disposable income, and, ultimately, to consumption and wealth. We document a continuous and sizable increase in wage inequality over the sample period. Changes in the distribution of hours worked sharpen the rise in earnings inequality before 1982, but mitigate its increase thereafter. Taxes and transfers compress the level of income inequality, especially at the bottom of the distribution, but have little effect on the overall trend. Finally, access to financial markets has limited both the level and growth of consumption inequality.
Keyword: Consumption, income, and wealth inequality, Inequality over the life cycle, and Wage dynamics Subject (JEL): D31 - Personal Income, Wealth, and Their Distributions, J31 - Wage Level and Structure; Wage Differentials, H31 - Fiscal Policies and Behavior of Economic Agents: Household, and E24 - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity