The role of education and household composition for transitory and permanent income inequality–evidence from PSID data

Transitory and permanent shocks to income have been shown to be important determinants of household consumption. This paper shows that there are significant differences in the trends of transitory and permanent income inequality between demographic groups since the 1980s. Using data from the Panel Study of Income Dynamics, educational attainment and the composition of a household are found to play a key role. While permanent inequality increases steadily for educated households, it is flat over large parts of the sample period for the less educated households. Transitory inequality increases for all households headed by couples whereas it is constant for single households. Altogether, permanent shocks account for a larger part of the income variance of educated households whereas transitory shocks are relatively more important for the less educated. These results are able to shed light on the transmission of changes in income inequality to consumption inequality.     

Consumption Inequality in China: Theory and Evidence from the China Health and Nutrition Survey

We investigate consumption inequality in China both theoretically by constructing a theoretical model that delineates the transmission channels by which income shocks affect consumption and empirically through an Unequally Spaced Dynamic Panel Data model estimation. We find that China is experiencing consumption inequality with the full partial insurance of consumption against both permanent and transitory income shocks, although the impact of both types of shock are larger than the case of the United States. The results are due to precautionary savings motives of the Chinese. We further document how income becomes more dispersed in China and show how the family background of a child affects his outcome to a large extent. Policy implications based on our findings are proposed.     

From income to consumption: measuring households partial insurance

This article computes the degree of consumption insurance with respect to transitory and permanent income shocks. The lack of income–consumption data in the US surveys forces researchers to use an empirical strategy to impute consumption. This procedure is avoided by using the Spanish Household Budget Continuous Survey, which contains true panel data on consumption and income information in the same survey. We find full insurance for transitory income shocks and partial insurance for permanent shocks for some sub-groups. For the full sample, a 10% permanent income shock induces a 4.8% permanent change in consumption, with higher insurance capacity for college, home-owner and high-wealth households. We also compute the role of durables and family income transfers as smoothing devices. The comparison of insurance level when based on true consumption data versus imputed consumption data shows that the use of imputed consumption underestimates permanent insurance.     

Intra- and international risk-sharing in the short run and the long run

We investigate empirically how industrialized countries and US states share consumption risk at horizons between 1 and 30 years. US federal states share about 50% of their permanent idiosyncratic risk through cross-state capital income flows. While insurance against transitory fluctuations in output is virtually complete, OECD countries do not share any of their permanent idiosyncratic risk. Our results suggest that purely transaction cost based theories cannot explain the home bias, since the potential welfare gains from insurance against permanent shocks would by far outweigh that of insuring against transitory variation. We conclude that permanent and transitory shocks constitute two qualitatively different kinds of risk and that various forms of endogenous market incompleteness may render permanent shocks a lot harder to insure, in particular at the international level.     

两种冲击视角下中国城乡经济波动福利成本研究*

经济波动福利成本的准确测算，一方面能够对经济波动根源的差异化理论做出评判，另一方面也直接关系到政府对于经济政策的选择。本文基于Lucas福利成本模型，采用BN分解公式对消费序列进行分解，估计了暂时性冲击和持久性冲击所造成的经济波动福利成本。本文研究证实，持久性冲击所造成的经济波动福利成本远大于暂时性冲击所造成的福利成本，避免不利供给因素所带来的持久性冲击，是增进城乡居民福祉的重要举措。这与当前所实施的“供给侧结构性改革”相契合。     

The Covariance Structure of East and West German Incomes and its Implications for the Persistence of Poverty and Inequality

Abstract. Based on data from the German Socio-Economic Panel (GSOEP), this paper analyzes the dynamics of equivalent income in East and West Germany in the years following reunification. Special emphasis is given to the separation of permanent and transitory components, the persistence of transitory shocks and their implications for the persistence of poverty and inequality. The results suggest that in West Germany, between 52 and 69 per cent of cross-sectional income inequality was permanent, and that poor individuals stayed in poverty for two years on average. In East Germany, the share of the permanent component in overall income inequality rose continuously from 20 per cent in 1990 to 72 per cent in 1998, reaching a level near the one that prevailed in West Germany during the same period. The rising importance of time-invariant components in East German incomes was also reflected in expected poverty durations which slightly increased from 1.47 years in 1990 to 1.67 years in 1998.     

CAN HOUSEHOLDS AND WELFARE STATES MITIGATE RISING EARNINGS INSTABILITY?

We compare the evolution of earnings instability in Germany and the United Kingdom, two countries which stand for different types of welfare states. Deploying data from the German Socio‐Economic Panel (SOEP) and the British Household Panel Survey (BHPS), we estimate permanent and transitory variances of male income over the period 1984–2009 and 1991–2006, respectively. Studies in this literature generally use individual labor earnings. To uncover the role of welfare state and households in smoothening earnings shocks, we compute different income concepts ranging from gross earnings to net equivalent household income. We find evidence that the overall inequality of earnings in Germany and the United Kingdom has been rising throughout the period due to both higher permanent earnings inequality and higher earnings volatility. However, taking institutions of the welfare state and risk‐sharing households into account, we find that the volatility of net household income has remained fairly stable. Furthermore, redistribution and risk insurance provided by the welfare state is more pronounced in Germany than in the United Kingdom.     

Revisiting the relationship between exchange rates and fundamentals

In this paper, we apply the permanent–transitory decomposition method to analyze the role of permanent and transitory shocks in explaining the apparent weak link between nominal exchange rates and economic fundamentals. The results suggest that for most of the countries we investigate, including Finland, Italy, Portugal, France and Switzerland, transitory shocks dominate exchange rate fluctuations, while permanent shocks dominate the variations in economic fundamentals. The findings therefore provide an alternative interpretation of the “exchange rate disconnect puzzle”. Moreover, the results also suggest that comprehensive modeling of transitory components in empirical models should not be neglected in studies of the dynamics of exchange rates.     

An empirical investigation of long-run growth in the UK

In this paper the long-run growth of the UK economy is analysed over the period 1855–1997, using a Markov-switching cointegration approach. We find that long-run economic growth can be explained by two permanent shocks, namely a technological shock and a labour supply shock. While technological progress seems to have a positive impact on the wage share and on income equality, the labour supply shock has the opposite effect, contributing to income inequality. Both shocks have a positive impact on aggregate output, but the bulk of long-run output growth variability is explained by the labour supply shock, suggesting that inequality is not harmful to growth.     

Consumption and Income Inequality in Australia

Consumption may be a more appropriate measure of household well-being than income or earnings. Using four ABS Household Expenditures Surveys collected between 1975 and 1993, we compare trends in consumption and income inequality among Australian households. We find that consumption is much more equal than income. While there were significant increases in both income and consumption inequality, consumption inequality rose by much less. One interpretation of the results is that some income inequality in Australia reflects transitory fluctuations which households can smooth,'and that part of the growth in income inequality reflects an increase in these transitory fluctuations.     

Inequality and the business cycle: evidence from U.S. survey data

ABSTRACT

We study the effects of macroeconomic shocks on measures of economic inequality obtained from U.S. survey data. To identify aggregate supply, aggregate demand, and monetary policy shocks, we estimate vector autoregressions and impose sign and zero restrictions on impulse response functions. We find that the effects of the macroeconomic shocks on inequality depend on the type of shock as well as on the measure of inequality considered. Contractionary monetary policy shocks increase expenditure and consumption inequality, whereas income and earnings inequality are less affected. Adverse aggregate supply and demand shocks increase income and earnings inequality, but reduce expenditure and consumption inequality. Our results suggest that different channels dominate in the transmission of the shocks. The earnings heterogeneity channel is consistent with the inequality dynamics after monetary policy shocks, but it appears to be less crucial when the economy is hit by either aggregate supply or aggregate demand shocks. Using variance decompositions, we find that although the macroeconomic shocks account for large shares of the variation in the macroeconomic variables, their contributions to the dynamics of the inequality measures are limited.     

Reexamining the permanent income hypothesis with uncertainty in permanent and transitory innovation states

In this paper, we reexamine the permanent income–consumption relationship analytically and empirically, based on the innovation regime-switching (IRS) model developed in [Kuan, C.M., Huang, Y.L., Tsay, R.S., 2005. An unobserved component model with switching permanent and transitory innovations. Journal of Business and Economic Statistics, 23, 443–454]. A novel feature of the IRS model is that it explicitly allows for uncertainty in innovation states. When the labor income follows an IRS process, it is shown that the agent’s perception on the likelihoods of income innovations being permanent and transitory plays a crucial role in determining the optimal forecasts on the change of consumption. The effect of a current labor income innovation on consumption is a weighted average of two distinct effects resulting from permanent and transitory innovations with the weights equal to the perceived likelihoods of the respective states. Also, past innovations may affect consumption when there are revisions in the perceived likelihoods of previous states. Our empirical study on US data shows that consumption indeed reacts significantly to the perceived likelihoods of innovation states. However, even after controlling for the effect of state uncertainty, we find consumption vastly underreacts to permanent innovations in labor income but reacts about the right magnitude to transitory ones when compared with the prediction of the permanent income hypothesis. This evidence is similar to [Elwood, S.K., 1998. Testing for excess sensitivity in consumption: A state-space unobserved components approach. Journal of Money, Credit, and Banking, 30, 64–82] but in sharp contrast with that found in [Hall, R.E., Mishkin, F.S., 1982. The sensitivity of consumption to transitory income: Estimates from panel data on households. Econometrica, 50, 461–480].     

RECURSIVE EQUILIBRIA IN AN AIYAGARI‐STYLE ECONOMY WITH PERMANENT INCOME SHOCKS

We prove existence of a recursive competitive equilibrium (RCE) for an Aiyagari‐style economy with permanent income shocks and derive important economic implications. We show that there exist equilibria where borrowing constraints are never binding and establish a nontrivial lower bound on the equilibrium interest rate. These results imply distinct consumption dynamics compared to existing studies. We present a new approach to solve the agent's problem that uses lattices of consumption functions to deal with permanent income shocks and an unbounded utility function. The approach provides a theoretical foundation for convergence of the time iteration algorithm widely used in applied work.     

Earnings dynamics of men and women in Finland: permanent inequality versus earnings instability

I decompose the earnings variance of Finnish male and female workers into its permanent and transitory components using the approach of Baker (J Labor Econ,15:338–375, 1997) and Haider (J Labor Econ, 19:799–836, 2001) in the spirit of scientific replication. I find that the increasing earnings inequality of men and women is driven by both the transitory and permanent components of earnings. In addition, I find considerable differences in the earnings dynamics of men and women, that have been largely neglected in previous studies of earnings dynamics. The inequality among men is dominated by the permanent component. Conversely, permanent and transitory components are of comparable magnitudes to women. As a corollary, men experience more stable income paths but display larger permanent earnings differences. Women, on the other hand, face more unstable earnings profiles but show smaller permanent differences in earnings.     

Inequality trends in Sweden 1978–2004

We document a clear increase in Swedish earnings inequality in the early 1990s, and that much of this increase was generated by movements in and out of the labor market. Inequality in disposable income and earnings net of taxes and transfers also increased, but much less than the increased inequality in pre-government earnings. These different developments are most likely explained by the generous Swedish welfare system. Consistent with these observations, we see no clear trend in consumption inequality.We also estimate stochastic processes for household earnings. A simple random-walk process captures much of the life-cycle dynamics. But we find clear evidence that the true earnings process is not a random walk. We demonstrate that some estimation methods result in severe upward bias in the estimated volatility of permanent shocks if serial correlation in temporary shocks is ignored.Our estimation results show that the increase in earnings inequality is almost entirely driven by an increase in residual earnings inequality. Moreover, this increase was mostly generated by an increased volatility of persistent shocks.     

Polarization patterns in economic development and innovation

This paper examines the polarization of economic development in African economies. Based on nonparametric and bipolarization frameworks, we find that countries tend to cluster in two classes, and that bipolarization has been accelerating over the period 1966–2008. We relate the evolution of income bipolarization to specialization in a country. The main sectors that tend to reduce income bipolarization are mining and services. We also study the effects of innovation on income polarization. In particular, we analyze short-run and long-run effects of innovation and their inter-relationship with income polarization. We show that the impact of innovation differs depending on its origin and its type. If innovation is resident, then trademarks outweigh patents. On the contrary, if the origin of innovation is non resident, then patents have a greater effect. Moreover, there is an adjustment process between trademarks residents and patents residents. In the short-run, when trademarks residents are too high, they quickly fall back toward patents residents level. We do not observe such adjustments between trademarks non residents and patents non residents. Last, unexpected shocks that affect patents (res. trademarks) have a permanent (res. transitory) effects on income polarization.     

A test of the household income process using consumption and wealth data

The evolution of household income can be explained almost equally well by rival models. However, rival models have very different implications for other household behaviours, such as consumption. I therefore test between two prominent models in the UK using panel data on consumption and wealth, as well as income, over 1991–2006. To operate the test, I show that long-lived income shocks transmit far less than one-for-one through to consumption, and particularly so for younger households. I then compare these estimates of transmission with estimates of households’ ability to smooth shocks, captured by the data on wealth. Conditional on the suitability of the consumption model, my estimates provide evidence against the restricted income process (RIP) and in favour of an alternative heterogeneous income process (HIP). This finding also explains why cross-sectional consumption inequality grew slowly over the period even though the variance of long-lived shocks was high. Finally, I conclude that it is important to consider mean reversion of shocks when constructing life-cycle consumption models.     

Regional consumption dynamics and risk sharing in Italy

In this paper, we propose a new method for investigating consumption insurance. Differently from the existing literature, we use error correcting VAR models in order to capture simultaneously the occurrence of risk sharing against permanent and transitory shocks. The proposed method is applied to the case of Italian regions. Empirical results obtained over the 1960–2001 period reveal that contrary to previous findings, Italian regions seem to shield against permanent shocks other than transitory ones. Although some biases are detected in the allocation process of resources, deviations from full consumption insurance are not as relevant as claimed in the previous literature on the Italian regions.     

Uncertainty,inequality and consumption preferences in urban China

In this paper we present an uncertainty–inequality–consumption model and empirically investigate the effect of uncertainty on the consumption behaviors of urban households with varying levels of socio-economic status in China. We observe that the condition of households that suffered from socio-economic inequality with respect to total consumption, educational expenditures, medical expenditures, and durable consumption worsened relative to other households when faced with income uncertainty. Income uncertainty did not affect the housing consumption of households that suffered from socio-economic inequality, but it substantially decreased their ability to consume other durables. As a result of the introduction of the modern enterprise system and the reform of the housing distribution system, households with a member employed in a management position suffer larger shocks of income uncertainty in total consumption, educational expenditures, medical expenditures, and housing consumption relative to household with all members employed in worker positions in 2002. Uncertainty with respect to medical and educational expenditures had more substantial effects on the non-durables consumption of low-income households than that of other households in 2002.     

Dissecting Exchange Rates and Fundamentals in the Modern Floating Era: The Role of Permanent and Transitory Shocks

In this paper, we apply a permanent–transitory decomposition method to analyze the link between nominal exchange rates and fundamentals in the modern floating era. The results suggest that transitory shocks dominate nominal exchange rate fluctuations, while permanent shocks dominate the variations in fundamentals. Therefore, the findings suggest that the nominal exchange rate should not be approximated by a pure random walk. Moreover, we find that unobserved fundamentals in the Taylor rule model can explain the transitory components in exchange rates.