Income Mobility and Welfare

By Tom Krebs, Pravin Krishna, William Maloney

January 28, 2013

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Tom Krebs, Pravin Krishna, and William Maloney. Income Mobility and Welfare, (USA: International Monetary Fund, 2013) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper develops a framework for the quantitative analysis of individual income dynamics, mobility and welfare. Individual income is assumed to follow a stochastic process with two (unobserved) components, an i.i.d. component representing measurement error or transitory income shocks and an AR(1) component representing persistent changes in income. We use a tractable consumption-saving model with labor income risk and incomplete markets to relate income dynamics to consumption and welfare, and derive analytical expressions for income mobility and welfare as a function of the various parameters of the underlying income process. The empirical application of our framework using data on individual incomes from Mexico provides striking results. Much of measured income mobility is driven by measurement error or transitory income shocks and therefore (almost) welfare-neutral. A smaller part of measured income mobility is due to either welfare-reducing income risk or welfare-enhancing catching-up of low-income individuals with high-income individuals, both of which have economically significant effects on social welfare. Decomposing mobility into its fundamental components is thus seen to be crucial from the standpoint of welfare evaluation.

Subject: Consumption, Income shocks, Labor, National accounts, Personal income, Wages

Keywords: Consumption, Income data, Income dynamics, Income mobility, Income process, Income shocks, Income specification, Labor income, Labor market risk, Mobility parameter, Personal income, Social welfare, Wages, WP

Publication Details

Pages:

28
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2013/024
Stock No:

WPIEA2013024
ISBN:

9781475551433
ISSN:

1018-5941

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