Earnings volatility trends and the great moderation: a multifactor residual approach

To explore trends in idiosyncratic income volatility, this paper employs a multifactor residual model to extract macroeconomic factors from individual changes in wages and total family income. The data used in this analysis is a subset of the persistently employed from the Panel Survey of Income Dynamics (PSID). Using this subset expands the income volatility literature by bridging an existing gap between studies using the PSID and others using a continuous work history sample. Improved aggregate economic conditions can explain much of the reduction in unconditional income volatility that took place during the Great Moderation, lasting from the mid-1980s into the 2000s. However, macro factors appear to be making larger contributions to individual and household income volatility following the recent rise in GDP volatility. In contrast, idiosyncratic volatility of income, that which remains after accounting for macroeconomic factors, has generally remained consistent. The stability of idiosyncratic income volatility suggests employment changes in the recent crisis were cyclical rather than structural. Keywords Income volatility * PSID * Great moderation * Multifactor residual * Labor earnings JEL E32 * J11
Introduction The period of the Great Moderation that began in 1984 represented a new lower volatility macroeconomic state where U.S. recessions were milder, and expansionary periods were less volatile. Multiple [...]