The Evolution of Household Income Volatility

This is part of the introduction to a new paper by Karen Dynan, Douglas Elmendorf, and Daniel Sichel on household income volatility (they find that volatility has increased in recent decades):

The Evolution of Household Income Volatility, by: Karen Dynan, Douglas Elmendorf, and Daniel Sichel: Editor's Note: The full version of this paper is available at the website for the B.E. Journal of Economic Policy and Analysis. An earlier working version of the paper can be directly downloaded [here].

1. Introduction Researchers have found it relatively straightforward to document changes in the volatility of the U.S. economy as a whole over the last several decades. The aggregate U.S. economy entered a period of relative stability known as the Great Moderation in the mid-1980s and, much more recently, has been in dramatic flux since the onset of the financial crisis and Great Recession in 2007 and 2008. However, aggregate trends do not necessarily translate into trends in the experiences of individual households. For example, the Great Moderation is generally thought to be a period over which the economy became more dynamic, with globalization, deregulation, and technological change increasing the competitive pressures and risks faced by workers. Given these developments, it is not clear that the economic environment facing individual households was in fact more stable during this period. Thus, to the extent that one is interested in household economic security, one is compelled to consider micro data. Accordingly, a large literature has developed that directly examines the volatility of earnings and income at the household level. While income volatility is not the same thing as the risk or uncertainty faced by households, changes in volatility are likely to be associated with changes in risk and uncertainty. ...

To summarize our results, we estimate that the volatility of household income—as measured by the standard deviation of two-year percent changes in income—increased about 30 percent between the early 1970s and the late 2000s. The rise in volatility did not occur in a single period but represented an upward trend throughout the past several decades; it occurred within each major education and age group as well. Yet, the run-up in volatility was concentrated in one important sense: It stemmed primarily from an increasing frequency of very large income changes rather than larger changes throughout the distribution of income changes.

Turning to the components of income, we estimate notable increases in the volatility of labor earnings and transfer income and a small increase in the volatility of capital income.  Household labor earnings (combining earnings of heads and spouses before estimating volatility at the household level) became more volatile even though the volatility of individual earnings (heads and spouses taken as individual observations) edged down. The explanation is that women’s earnings became less volatile while men’s earnings became more volatile, and the latter matters more for household earnings because men earn more than women on average. We show that rising volatility in men’s earnings owes both to rising volatility in earnings per hour and in hours worked, though our interpretation could be affected by changes in PSID methodology. And we demonstrate that earnings shifts between household members, as well as shifts in market income and transfer income, provide only small offsets to each other. ...