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Nonlinear household earnings dynamics, self-insurance, and welfare

De Nardi, Mariacristina, Fella, Giulio and Paz-Pardo, Gonzalo (2018) Nonlinear household earnings dynamics, self-insurance, and welfare. CFM Discussion Paper Series (CFM-DP2018-17). Centre For Macroeconomics, London School of Economics and Political Science, London, UK.

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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.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.centreformacroeconomics.ac.uk/Home.aspx
Additional Information: © 2018 Centre for Macroeconomics
Divisions: Centre for Macroeconomics
Subjects: H Social Sciences > HB Economic Theory
JEL classification: D - Microeconomics > D1 - Household Behavior and Family Economics > D14 - Personal Finance
D - Microeconomics > D3 - Distribution > D31 - Personal Income, Wealth, and Their Distributions
E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E21 - Macroeconomics: Consumption; Saving; Aggregate Physical and Financial Consumer Wealth
J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs > J31 - Wage Level and Structure; Wage Differentials by Skill, Training, Occupation, etc.
Sets: Research centres and groups > Centre for Macroeconomics
Date Deposited: 05 Oct 2018 14:43
Last Modified: 04 Sep 2019 23:26
URI: http://eprints.lse.ac.uk/id/eprint/90375

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