Improving the Measurement of Earnings Dynamics

62 Pages Posted: 19 Dec 2016

See all articles by Moira Daly

Moira Daly

Copenhagen Business School

Dmytro Hryshko

University of Alberta

Iourii Manovskii

University of Pennsylvania - Department of Economics; IZA Institute of Labor Economics

Date Written: December 2016

Abstract

The stochastic process for earnings is the key element of incomplete markets models in modern quantitative macroeconomics. We show that a simple modification of the canonical process used in the literature leads to a dramatic improvement in the measurement of earnings dynamics in administrative and survey data alike. Empirically, earnings at the start or end of earnings spells are lower and more volatile than the observations in the interior of earnings histories, reflecting the effects of working less than the full year as well as deviations of wages due to e.g. tenure effects. Ignoring these properties of earnings, as is standard in the literature, leads to a substantial mismeasurement of the variances of permanent and transitory shocks and induces the large and widely documented divergence in the estimates of these variances based on fitting the earnings moments in levels or growth rates. Accounting for these effects enables more accurate analysis using quantitative models with permanent and transitory earnings risk, and improves empirical estimates of consumption insurance against permanent earnings shocks.

Suggested Citation

Daly, Moira and Hryshko, Dmytro and Manovskii, Iourii, Improving the Measurement of Earnings Dynamics (December 2016). NBER Working Paper No. w22938. Available at SSRN: https://ssrn.com/abstract=2887200

Moira Daly (Contact Author)

Copenhagen Business School

Dmytro Hryshko

University of Alberta ( email )

Edmonton, Alberta T6G 2R3
Canada

Iourii Manovskii

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6880 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~manovski/

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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