Nonlinear Household Earnings Dynamics, Self-Insurance, and Welfare

65 Pages Posted: 21 Feb 2018

See all articles by Mariacristina De Nardi

Mariacristina De Nardi

University College London, Economics Dpt.; Federal Reserve Bank of Chicago; National Bureau of Economic Research (NBER) - Public Economics

Giulio Fella

Queen Mary, University of London

Gonzalo Paz-Pardo

University College London

Date Written: February 2018

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 estimate two alternative processes for household after-tax earnings and study their implications using a standard life-cycle model. Both processes feature a persistent and a transitory component, but while the first one is the canonical linear process with stationary shocks, the second one has substantially richer earnings dynamics, allowing 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. The richer earnings process also implies lower welfare costs of earnings risk.

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Suggested Citation

De Nardi, Mariacristina and Fella, Giulio and Paz-Pardo, Gonzalo, Nonlinear Household Earnings Dynamics, Self-Insurance, and Welfare (February 2018). NBER Working Paper No. w24326. Available at SSRN: https://ssrn.com/abstract=3127067

Mariacristina De Nardi (Contact Author)

University College London, Economics Dpt. ( email )

Gower Street
London WC1E 6BT, WC1E 6BT
United Kingdom

Federal Reserve Bank of Chicago ( email )

Research Department
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Chicago, IL 60604
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HOME PAGE: http://www.nber.org/~denardim

National Bureau of Economic Research (NBER) - Public Economics ( email )

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HOME PAGE: http://www.nber.org/~denardim

Giulio Fella

Queen Mary, University of London ( email )

Mile End Road
London E1 4NS, London E1 4NS
United Kingdom

Gonzalo Paz-Pardo

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

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