There has been a dramatic increase in wage inequality in the United States over the past thirty years. This trend has generated a vast amount of research attempting to identify its causes, and has been accompanied by a vibrant public debate on the consequences of a more unequal society. However, the effects of rising wage inequality for the macroeconomy are still not very well understood by economists. For example, inequality in consumption and hours worked has, perhaps surprisingly, increased only modestly in recent decades. The goal of this proposal is to provide a comprehensive quantitative assessment of the macroeconomic and welfare implications of rising wage inequality for the U.S. economy.
The project will provide a quantitative answer to four distinct, but strictly interrelated questions. First, to what extent can changes in the wage structure account for the observed dynamics of cross-sectional dispersion in hours worked, earnings, consumption, and wealth in the United States? Second, can a rising skill-premium coupled with greater wage instability explain the recent surge in non-participation among prime-aged males? Third, how important for understanding the dynamics of inequality are the rise in female labor-force participation, the narrowing of the gender wage gap, and intra-family insurance? Finally, what are the welfare costs of the observed rise in uninsurable labor market risk for U.S. households, given incomplete financial and insurance markets?
All these components of the project share a common methodology, which can be summarized in two stages. First, panel-data statistical techniques are used to provide an accurate empirical assessment of the changes in the individual (or joint family) stochastic process for wages. Next, the time-varying wage process is used as an input into calibrated overlapping-generations incomplete-markets model economies in order to generate, through numerical simulations, predictions for the variables of interest. Our approach therefore combines a rigorous econometric analysis of changing wage dynamics (typical of labor economics) with state-of-the-art quantitative theory (typical of macroeconomics) in order to isolate the effects of rising wage inequality on the distribution at the household level of consumption, savings, labor supply and, ultimately, welfare.
Broader Impacts: Understanding these issues can help economists and policy-makers decide how much attention they should pay to trends and fluctuations in cross-sectional inequality relative to the more traditional concerns of aggregate economic growth and business-cycle fluctuations. Moreover, by examining the mechanisms via which the level of dispersion in a large set of economic variables is jointly determined, our study suggests directions in which policy interventions should be targeted in order to mitigate the costs of rising wage inequality on society.
