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Friday, April 02, 2010

The Volatility of Household Income

From The Income Rollercoaster: Rising Income Volatility and its Implications, by Karen Dynan at Brookings:

...Figure 1 shows the evolution of household income volatility over time.


As can be seen, the standard deviation of the percent change in household income trended up in the 1970s, stabilized a bit in the 1980s, but then turned up again after 1990. All told, household income volatility increased by about one-third between the late 1960s and the middle part of this decade.

The increase in volatility has largely resulted from an increase in the frequency of large household income changes. The solid red line in Figure 2 shows the fraction of households experiencing a drop in income of 50 percent or more, and the dashed blue line shows the same for increases in income.


The shaded areas represent recessions (as dated by the National Bureau of Economic Research); as expected, large income declines tend to go up during such periods, and large increases tend to go down. One can also see that the prevalence of large income increases was particularly high during the late 1990s when macroeconomic conditions were booming.

The figure shows a decided uptrend in the frequency of large drops in income, with about 7 percent of households experiencing declines in income of 50 percent or more in the late 1960s and 12 percent experiencing such drops in the middle part of the 2000s. The share of households seeing a 50 percent or more increase in income rose from about 8 percent to 10 percent over the period. ...

The conclusion:

Household income volatility appears to have trended significantly upward over the past several decades, with much of the rise tied to an increase in the frequency of very large changes in income. Volatility of earnings per hour has risen more sharply than the volatility of hours, suggesting an important involuntary component to the increase in income variability. Expanded access to credit has probably mitigated the degree to which income declines translate into consumption declines, but this development has posed other risks to household economic security, as have other trends in household financial opportunities.

It is too early to know what effects the current economic crisis will have on these trends. The high current degree of weakness in labor markets—together with the expectation that the economic recovery will proceed only slowly—implies that household income volatility may be unusually elevated for several years to come.

And as the crisis ends and we begin to return to normal, the pressures from the federal budget will make it very difficult to expand social insurance programs to cope with the increased uncertainty that households face. There will be many calls to reduce the size of government, and it will be a fight just to maintain the level of protection that these programs currently offer.

    Posted by on Friday, April 2, 2010 at 06:03 PM in Economics | Permalink  Comments (26)


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