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Nonlinear household earnings dynamics, self-insurance, and welfare

Author

Listed:
  • Mariacristina De Nardi

    (University College London (UCL)
    Federal Reserve Bank of Chicago
    Institute for Fiscal Studies (IFS)
    Centre for Economic Policy Research (CEPR))

  • Giulio Fella

    (Queen Mary University of London
    Centre for Macroeconomics (CFM)
    Institute for Fiscal Studies)

  • Gonzalo Paz-Pardo

    (University College London (UCL))

Abstract

Earnings dynamics are much richer than typically assumed in macro models with heterogeneous agents. This holds for individual-pre-tax and household-post-tax earnings and across administrative (Social Security Administration) and survey (Panel Study of Income Dynamics) data. We study the implications of two processes for household, post-tax earnings in a standard life-cycle model: a canonical earnings process (that includes a persistent and a transitory shock) and a rich earnings dynamics process (that allows for age-dependence of moments, non-normality, and nonlinearity in previous earnings and age). Allowing for richer earnings dynamics implies a substantially better fit of the evolution of cross-sectional consumption inequality over the life cycle and of the individual-level degree of consumption insurance against persistent earnings shocks. Richer earnings dynamics also imply lower welfare costs of earnings risk, but, as the canonical earnings process, do not generate enough concentration at the upper tail of the wealth distribution.

Suggested Citation

  • Mariacristina De Nardi & Giulio Fella & Gonzalo Paz-Pardo, 2018. "Nonlinear household earnings dynamics, self-insurance, and welfare," Discussion Papers 1817, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:1817
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    as
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    More about this item

    Keywords

    Earnings risk; Savings; Consumption; Inequality; Life cycle;
    All these keywords.

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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