Learning Your Earning: Are Labor Income Shocks Really Very Persistent?

By Fatih Guvenen. 2007

443 citations recorded by the source corpus.

The current literature offers two views on the nature of the income process. According to the first view, which we call the “restricted income profiles” (RIP) model (MaCurdy, 1982), individuals are subject to large and very persistent shocks, while facing similar life-cycle income profiles (conditional on a few characteristics). According to the alternative view, which we call the “heterogeneous income profiles” (HIP) model (Lillard and Weiss, 1979), individuals are subject to income shocks with modest persistence, while facing individual-specific income profiles. While labor income data does not seem to distinguish between the two hypotheses in a definitive way, the RIP model is overwhelmingly used to specify the income process in economic models, because it delivers implications consistent with certain features of consumption data. In this paper we study the consumption-savings behavior under the HIP model, which so far has not been investigated. In a life-cycle model, we assume that individuals enter the labor market with a prior belief about their individual-specific profile and learn over time in a Bayesian fashion. We find that learning is slow, and thus initial uncertainty affects decisions throughout the life-cycle allowing us to estimate the prior uncertainty from consumption behavior later in life. This procedure implies that 40 percent of variation in income growth rates is forecastable by individuals at time zero. The resulting model is consistent with several features of consumption data including (i) the substantial rise in within-cohort consumption inequality (Deaton and Paxson 1994), (ii) the non-concave shape of the age-inequality profile (which the RIP model is not consistent with), and (iii) the fact that consumption profiles are steeper for higher educated individuals (Carroll and Summers 1991). These results bring new evidence from consumption data on the nature of labor income risk.

Subfields: Accounting, Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/f0aca7594cdc430b6d375fb4388fd85f25ebaeec

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Citations in the corpus

The Dynamics of Inequality (2016, unknown): “Combining evidence from the IRS public use panel of tax returns and from Guvenen, Ozkan, and Song (2014), they show that this measure of μH has increased substantially from 1979-81 to 1988-90 to 1995-96.”
Career Choice and Wage Growth (2011, background): “26 The closest example of a model that allows for this level of ex ante heterogeneity is in Guvenen (2007), where individuals are allowed to have heterogeneous profiles in wages.”
Multidimensional Skill Mismatch (2020, unknown): “These scores were previously used by Heckman et al. (2006), and Bowles et al.”
Capital Taxation: Quantitative Explorations of the Inverse Euler Equation (2012, unknown): “…values explored by Aiyagari (1994).27 The second view, dating back to Lillard and Weiss (1979) and Hause (1980) and developed more recently by Guvenen (2007, 2009), argues that the 27 This literature typically fits an autoregressive moving-average model ARMA(1, 1) instead of an…”
The distribution of wealth and …scal policy in economies with …nitely lived agents (2008, unknown): “The combination of idiosyncratic and trend-stationary components of labor income …nds some support in the data; see Guvenen (2007).”
Inequality and the Lifecycle (2011, methodology): “This specification is similar to the one used by Guvenen, Kuruscu, and Ozkan (2009) and is the same as that in Heathcote, Storesletten, and Violante (2010b). Both of these papers provide evidence that 1 minus the marginal tax rate is approximately log linear in earnings for the United States.”
Heterogeneous Income Profiles and Lifecycle Bias in Intergenerational Mobility Estimation (2016, background): “Guvenen (2007; 2009) argue that accounting for heterogeneous income profiles yields more accurate predictions about life-cycle consumption behavior. Browning et al. (2010) present a model with heterogeneity in many additional parameters.”
The Surprising Power of Age-Dependent Taxes (2011, unknown): “subject to feasibility (21) and incentive constraints:”
Spain is Different: Falling Trends of Inequality (2009, background): “However, Guvenen (2007) argues that people may not know their own rate of growth of earnings.”
The base for direct taxation (2008, unknown): “Their calculations for the US come up with a 139 Taking a different modeling approach, Guvenen (2007) chooses to model a process whereby individuals gradually learn about their type and update their expectations as they move through early working life.”
Identifying distributional characteristics in random coefficients panel data models (2009, background): “…as production function models with firm-specific technological parameters.2 The estimation of heterogeneous treatment effects is another 1For examples of earnings models with individual-specific slopes or profiles, see Lillard and Weiss (1979), Baker (1997), Haider (2001), and Guvenen (2007, 2009).”