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Earnings dynamics and top-earnings inequality

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  • Karl Harmenberg
  • Raysa Lizarraga

Abstract

We introduce a simple generalization of the canonical permanent-transitory earnings process, a square-root process. The square-root process generates a Pareto tail in earnings and is able to match the dynamics of top-earnings inequality over the life cycle while retaining a good match to the covariance structure of earnings. By contrast, the canonical model fails to match the dynamics of top-earnings inequality over the life cycle. Since our square-root process is simple, with only one state variable, it can easily be used in structural macroeconomic models.

Suggested Citation

  • Karl Harmenberg & Raysa Lizarraga, 2025. "Earnings dynamics and top-earnings inequality," Working Papers 01/2025, Centre for Household Finance and Macroeconomic Research (HOFIMAR), BI Norwegian Business School.
    • Handle: RePEc:bbq:wpaper:0014
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    File URL: https://hdl.handle.net/11250/3177434
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