Fatih Guvenen University of Minnesota

Syllabus for ECON 8501 Fall 2012

This course covers topics at the nexus of macro and labor economics. The main goals of this course are to expose students to research questions at the current frontier, discuss a variety of open questions in this area that can lead to research papers (or possibly to a dissertation), and equip with the tools necessary to tackle these questions. Course Requirements

To get credit for this course you will need to (i) make in-class presentations of papers that I will assign (typically one lecture in advance), (ii) write a referee report on one of the papers indicated with a (#) sign, and (iii) write an original research proposal.

The deadline for choosing a paper for referee report is October 8th, class time. If you haven’t chosen a paper by then I will assign you one in class that day. The due date for the referee report is October 22nd, class time.

The homework assignments will develop various empirical and computational skills and will allow you to familiarize with commonly used data sets and software packages. The research proposal should outline a clear research question and describe how you intend to answer the question posed (which data set you would use, a description of the model, the algorithm for solving it, etc). The proposal will be judged based on the originality of the idea (or the importance of the contribution), the feasibility of the exercise and how specific and detailed the proposal is. An ideal proposal would be one where somebody else could take it and follow the steps you describe to answer the question. Each student will present his/her proposal during the class time on October 22nd. The completed written proposal is due October 29th.

Finally, students will be assigned to present some of the papers on the reading list below. Depending on total enrollment, each student could expect to make up to 3 presentations during the semester.

Legend: **: I cover in class. *: A student presents. #: Papers for referee report. Course Schedule:

• The class will meet on Mondays from 2:30pm to 5:30pm with a 10-minute break in the middle.

Books and Useful Reading Materials

• “The Race Between Education and Technology,” by Claudia Goldin and Lawrence Katz.

• Why Does College Cost So Much? by Archibald and Feldman

• “Macroeconomics with Heterogeneity: A User’s Guide,” Fatih Guvenen, Federal Reserve Bank of Richmond Economic Quarterly, 2011.

• “Quantitative Macroeconomics with Heterogeneous Households,” Jonathan Heathcote, Kjetil Storesletten, and Gianluca Violante, Annual Review of Economics, 2009.

• Browning, M., L. P. Hansen, and J. J. Heckman (1999): “Micro data and general equilibrium models,” in Handbook of Macroeconomics, ed. by J. B. Taylor, and M. Woodford.

• Blundell Richard, and Tom MaCurdy (1999): “Labor Supply: A Review of Alternative Approaches,” in Handbook of Labor Economics, vol. 3, North Holland

I. Evolution of Wages over the Lifecycle

A. Economic Models of Wage formation: A major question of labor economics is the determination of wages: in particular why do wages grow over the lifecycle? And what determines the relative wages of different types of workers (young-vs-old, men-vs-women, married-vs-single households, etc.)? We will study several theoretical models of wage formation that highlight some interesting mechanisms. We will spend more time on variants of the human capital model, but will also discuss models with search and matching, learning-by-doing, learning about workers’ productivity, and learning with limited commitment on the part of worker.

1. Human capital:

Y. Ben-Porath. (1967) “The Production of Human Capital and the Life Cycle of Earnings,” Journal of Political Economy, 75 (August), 352-65.

G. Becker. (1993) Human Capital, 3rd ed. Chicago: University of Chicago Press, pp. 1-66.

*J. Heckman. (1976) “A Life-Cycle Model of Earnings, Learning, and Consumption,” Journal of Political Economy, 84 (August), s11-s44.

J. Mincer. (1997) The Production of Human Capital and the Life Cycle of Earnings: Variations on a Theme, Journal of Labor Economics, 15 (January), S26-S47.

**Kuruscu, Burhanettin (2006): “Training and Lifetime Income, American Economic Review, Vol. 96, Issue 3, June 2006.

*Rosen, Sherwin (1972): “Learning and Experience in the Labor Market,” Journal of Human Resources, Vol 7, No 3, pp. 326-342.

*Huggett, Mark, Gustavo Ventura, and Amir Yaron (2007): “Sources of Lifetime Inequality,” Working Paper, Georgetown University.

D. Acemoglu and J. Pischke. (1998) Why Do Firms Train? Theory and Evidence. Quarterly Journal of Economics, Vol. 113.1 (February), 79-119.

D. Acemoglu and J.S. Pischke. (1999) Beyond Becker: Training in Imperfect Labor Markets, Economic Journal, 109.453 (February), 112-42.

2. Learning-by-Doing, Learning about Productivity (Spiced up with Search-Matching, Limited Commitment, etc):

L. Rapping (1965): “Learning and World War II Production Functions, “The Review of Economics and Statistics, Vol. 47, No. 1, pp. 81-86.

**P. Thompson: “How Much Did the Liberty Shipbuilders Learn? New Evidence for an Old Case Study.” Journal of Political Economy, 109(1):103-137. See also http://www.fiu.edu/~thompsop/liberty/photos/liberty_summary.html.

*B. Jovanovic and Nyarko (1996): “Learning by Doing and the Choice of Technology,” Econometrica, No 6, 1299-1310.

**B. Jovanovic (1979) “Job Matching and the Theory of Turnover,” Journal of Political Economy, 87.5 (October), 972-990.

B. Jovanovic (1979) “Firm-Specific Capital and Turnover,” Journal of Political Economy, 87.6 (December), 1246-60.

**M. Harris, and Bengt Holmstrom (1982): “A Theory of Wage Dynamics,” Review of Economic Studies, Vol. 49, pp. 315-333.

H.S. Farber and R. Gibbons. (1996) “Learning and Wage Dynamics,” Quarterly Journal of Economics, 111.4 (November), 1007-47.

**B. Guler, F. Guvenen, and G. Violante (2008): “Joint-Search Theory: New Opportunities and New Frictions,” Working Paper.

3. Education:

Rothschild and White (1995): “The Analytics of the Pricing of Higher Education and Other Services in Which the Customer is Also the Input,” JPE.

Hoxby (1997): “How the Changing Structure of Higher Education Explains College Tuition,” NBER Working paper.

Goldin (1999): “A Brief History of Education”

Archibald and Feldman (2010): “The Real Cost of Education,” Article in . And discuss the reasons behind the rise in costs of education. Restuccia and Vandenbraucke (2010): “The Evolution of Education: A Macroeconomic Analysis,” U Toronto Working Paper.

Guvenen and Rendall (2012): “Emancipation Through Education,” UMN Working Paper.

#Gallipoli, Meghir, Violante (2010): “Equilibrium Effects of Education Policies: A Quantitative Evaluation,” NYU Working paper.

4. Occupational Choice:

A. Roy. (1951) “Some Thoughts on the Distribution of Earnings,” Oxford Economic Papers, 235-46.

Kambourov and Manovskii (2009): “Occupational Mobility and Wage Inequality,” Review of Economic Studies.

B. Statistical Models of Wages Over the Lifecycle

*Guvenen, F. (2008): “An Empirical Investigation of Income Processes,” NBER Working Paper No 13394.

**MaCurdy, Thomas (1982): “The Use of Time-Series Processes to Model the Error Structure of Earnings in a Longitudinal Data Analysis,” Journal of Econometrics, Vol. 18, pp. 83-114.

*Storesletten, Kjetil, Chris Telmer and Amir Yaron (2004): “Cyclical Dynamics in Idiosyncratic Labor- Market Risk,” Journal of Political Economy, vol. 112 (3), pp. 695-717.

**Guvenen, Fatih, Serdar Ozkan and Jae Song (2012): “The Nature of Countercyclical Income Risk,” NBER Working Paper No 18035.

Guvenen, Fatih, Fatih Karahan, Serdar Ozkan and Jae Song (2012): “A User’s Guide for Labor Income Risk.”

*Browning, Martin, Mette Ejrnaes, and Javier Alvarez: “Modelling Income Processes with Lots of Heterogeneity,” Review of Economic Studies, 2010.

Abowd, John, and David Card (1989): “On the Covariance Structure of Earnings and Hours Changes,” Econometrica, Vol. 57, pp.411-445.

Baker, Michael (1997): “Growth-rate Heterogeneity and the Covariance Structure of Life-Cycle Earnings,” Journal of Labor Economics, Vol. 15, pp. 338-375

Baker, Michael and Gary Solon (2003): “Earnings Dynamics and Inequality Among Canadian Men, 1976-1992: Evidence from Longitudinal Tax Records,” Journal of Labor Economics, Vol 21, pp. 289- 321.

Haider Steve J. (2001): “Earnings Instability and Earnings Inequality of Males in the United Stated: 1967- 1991, Journal of Labor Economics, Vol. 19, pp. 799-836. Lillard, Lee A. and Robert Willis (1978): “Dynamic Aspects of Earning Mobility,” Econometrica, Vol. 46, p. 985-1012.

Lillard, Lee A., and Yoram A Weiss (1979): “Components of Variation in Panel Earnings Data: American Scientists, 1960-70,” Econometrica, Vol. 47, pp. 437-454.

Meghir, Costas, and Luigi Pistaferri (2004): “Income Variance Dynamics and Heterogeneity,” Econometrica.

Topel, Robert H. (1990): “Specific Capital, Mobility and Wages: Wages rise with Job Seniority,” NBER Working Paper No. 3294.

II. Evolution of Wages (and inequality) Over Time

The US wage distribution has experienced significant changes since the 1970’s. For example, total wage inequality has widened throughout the period whereas the college-high school premium fell monotonically in the 1970’s and then rose subsequently. A large part of the rise in wage inequality is not “explained” by observables (such as age and education) though—so it is called “residual inequality.” Finally, these developments coincided with a substantial slowdown in labor productivity growth (as well as median wage growth). We first document these facts and then study models that highlight mechanisms for these changes.

A. Empirical Facts

* Lawrence Katz and David Autor (1999) “Changes in the Wage Structure and Earnings Inequality,” in O. Ashenfelter and D. Card, eds., Handbook of Labor Economics, vol. 3A, pp. 1463-1555.

**Acemoglu, Daron (2002) “Technical Change, Inequality and the Labor Market.” Journal of Economic Literature.

David Autor, Lawrence Katz, and Melissa Kearney (2007). Trends in U.S. Wage Inequality: Revising the Revisionists, mimeo, Harvard University

*L. Katz and K.M. Murphy (1992) “Changes in Relative Wages, 1963-87: Supply and Demand Factors,” Quarterly Journal of Economics, February, 35-78.

*C. Juhn, K.M. Murphy, and B. Pierce (1993) “Wage Inequality and the Rise in the Returns to Skill.” Journal of Political Economy 101 (June): 410-42.

C. Goldin and L. Katz (2007), “The Race between Education and Technology: The Evolution of U.S. Educational Wage Differentials, 1890 to 2005,” NBER WP No. 12984, March.

D. Card and T. Lemieux (2001), “Can Falling Supply Explain the Rising Return to College for Younger Men? A Cohort-Based Analysis,” Quarterly Journal of Economics 116(May): 705-46.

J. Bound and G. Johnson (1992) “Changes in the Structure of Wages in the 1980s: An Evaluation of Alternative Explanations.” American Economic Review 82 (June): 371-92. T. Lemieux (2006), “Post-Secondary Education and Increasing Wage Inequality,” NBER WP No. 12077, March.

T. Piketty and E. Saez. (2006), “The Evolution of Top Incomes: A Historical and International Perspective,” American Economic Review 96 (May), 200-205.

Gottschalk, Peter and Robert Moffitt (1994). The Growth of Earnings Instability in the U.S. Labour Market. Brookings Papers of Economic Activity.

Moffitt, Robert and Peter Gottschalk (2002). Trends in the Transitory Variance of Earnings in the United States. Economic Journal.

B. Models

**D. Acemoglu (1998) “Why Do New Technologies Complement Skills? Directed Technical Change and Wage Inequality,” QJE 113 (November), 1055-1089.

*Guvenen Fatih and Burhanettin Kuruscu (2007). Understanding the Evolution of the U.S. Wage Distribution: A Theoretical Analysis, Working Paper, University of Minnesota.

**Guvenen Fatih and Burhanettin Kuruscu (2007). A Quantitative Analysis of the Evolution of the U.S. Wage Distribution: 1970-2000, Working Paper, University of Minnesota.

P. Beaudry and D. Green (2003), “Wages and Employment in the United States and Germany: What Explains the Difference?” American Economic Review 93 (June), 573-602.

**Per Krusell, Lee Ohanian, Jose-Victor Ríos-Rull and Gianluca Violante (2000). Capital-Skill Complementarity and Inequality: A Macroeconomic Analysis, Econometrica Gianluca Violante (2007): “Skill-Biased Technical Change,” The New Palgrave Dictionary of Economics, 2nd edition, MacMillan. #Kambourov Gueorgui, and Iourii Manovskii (2007). Occupational Mobility and Wage Inequality, mimeo University of Pennsylvania.

**Garicano, Luis, and Esteban Rossi-Hansberg (2007): “Organization and Inequality in a Knowledge Economy,” Quarterly Journal of Economics, 121:4, 1383-1435.

Violante, Giovanni (2002): Technological Acceleration, Skill Transferability, and the Rise of Residual Inequality,” Quarterly Journal of Economics, Vol 117, pp 297-338.

C. Understanding the Welfare Consequences

**Attanasio, Orazio and Steve Davis (1996). Relative Wage Movements and the Distribution of Consumption, Journal of Political Economy.

**Blundell, Richard and Ian Preston (1998). Consumption Inequality and Income Uncertainty. Quarterly Journal of Economics.

*Aguiar, Mark and Mark Bils (2012). “Has Consumption Inequality Mirrored Income Inequality?” Princeton Working Paper. *Krueger, Dirk and Fabrizio Perri (2006). Does Income Inequality Lead to Consumption inequality: Evidence and Theory. Review of Economic Studies.

Attanasio, Orazio, Erich Battistin, and Hide Ichimura (2005). What Really Happened to Consumption Inequality in the US? in Measurement Issues in Economics-The Paths Ahead: Essays in Honor of Zvi Griliches, University of Chicago Press.

Heathcote Jon, Kjetil Storesletten and Gianluca Violante (2012): From Wages to Welfare: Decomposing Gains and Losses from Rising Inequality. MPLS Fed working paper.

Heathcote Jon, Kjetil Storesletten and Gianluca Violante (2010): The Macroeconomic Implications of Rising Wage Inequality in the US, Journal of Political Economy.

Krueger, Dirk and Fabrizio Perri (2003), On the welfare consequences of the increase in inequality in the United States, 2003 NBER Macro Annual.

III. Incomplete Market Models (of consumption, hours, etc)

In this part, we first document the empirical facts about the allocation of consumption and labor hours over the lifecycle. We will discuss some inherent difficulties in documenting these “facts” (hence the quotation marks!) which is leading to a certain degree of disagreement in the current literature about what the facts actually are. We then discuss incomplete-market models—which (typically) take the wage process as given and solve for consumption, labor supply, etc. allocations—that attempt to explain these empirical facts.

**Lucas, Robert E., Jr (2003): “Macroeconomic Priorities,” American Economic Review.

**Aiyagari, Rao S. (1994): “Uninsured Idiosyncratic Shock and Aggregate Saving,” Quarterly Journal of Economics, Vol. 109, No.3, pp. 659-684.

**Deaton and Paxson (1994): “Intertemporal Choice and Inequality,” Journal of Political Economy, Vol. 102, pp. 437-467.

**Carroll, Christopher D., and Lawrence Summers (1991): “Consumption Growth Parallels Income Growth: Some New Evidence,” in National Savings and Economic Performance, eds. D. Bernheim and B. Shoven, Chicago: University of Chicago Press, pp. 305-343.

**F. Guvenen (2007): “Learning Your Earning: Are Labor Income Shocks Really Very Persistent? American Economic Review, Vol. 97, No. 3, pp. 687-712.

**F. Guvenen, and Anthony Smith (2010): “Inferring Labor Income Risk from Economic Choices: An Indirect Inference Approach,” Working paper.

Gourinchas and Parker (2002): “Consumption Over the Life Cycle,” Econometrica, Vol 70, pp. 47-89.

Storesletten, Kjetil, Chris Telmer and Amir Yaron (2003): “Consumption and Risk-sharing Over the Life- cycle,” Journal of Monetary Economics. **E. Hurst and M. Aguiar (2005): “Consumption versus Expenditure,” Journal of Political Economy.

**E. Hurst and M. Aguiar (2008): “Deconstructing Lifecycle Expenditures,” Working Paper, University of Rochester.

*E. Hurst and M. Aguiar (2007): “Lifecycle Prices and Production,” American Economic Review.

E. Hurst and M. Aguiar (2007): “Measuring Trends in Leisure Over Time,” Quarterly Journal of Economics.

*Badel and Huggett (2012): Interpreting Life-Cycle Inequality Patterns as an Efficient Allocation: Mission Impossible? St Louis Fed working paper.

#Valery Ramey (2008): “How Much has Leisure Really Increased Since 1965,” Working Paper, UCSD.

Attanasio, Orazio P., James Banks, Costas Meghir and Guiglielmo Weber (1999): “Humps and Bumps in Lifetime Consumption,” Journal of Business and Economics Statistics, Vol 17, pp. 22-35.

Carroll, Christopher D. (1992): “The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence,” Brookings Papers on Economic Activity, pp. 61--156.

**Krusell, Per, and Anthony A. Smith Jr. (1997): “Income and Wealth Heterogeneity, Portfolio Choice, and Equilibrium Asset Returns,” Macroeconomic Dynamics, Vol. 1, pp. 387-422.

Krusell, Per, and Anthony A. Smith Jr. (1998): “Income and Wealth Heterogeneity in the Macroeconomy,” Journal of Political Economy, Vol. 106, pp. 867-896.

Heathcote Jon, Kjetil Storesletten and Gianluca Violante (2007): “Two Views of Inequality over the Life Cycle,” Journal of the European Economic Association.

#Heathcote Jon, Kjetil Storesletten and Gianluca Violante (2007): “Consumption and Labor Supply with Partial Insurance,” Working Paper, NYU.

#Huggett, Mark and Alejandro Badel (2007): “Interpreting Life-Cycle Inequality Patterns as an Efficient Allocation: Mission Impossible?”, mimeo, Georgetown University.

#A. Erosa, Luisa Fuster, and G. Kambourov (2008): “The Heterogeneity and Dynamics of Individual Labor Supply over the Life-Cycle: Facts and Theory,” Working Paper, University of Toronto.

R. Blundell, Luigi Pistaferri and Ian Preston (2007): “ Consumption Inequality and Partial Insurance, American Economic Review, Forthcoming.

#Greg Kaplan and Gianluca Violante (2008): “How much Insurance in Bewley Models?” Working Paper, NYU.

IV. Differences in Labor Market Outcomes: US vs. Europe

The substantial rise in wage inequality observed in the US (and UK) has not been observed in most of continental Europe. Moreover, the typical American worker now works many more hours than his/her counterpart in Continental Europe. In this part, we examine if these, and quite a few other, differences between the US and European labor market outcomes can be explained by differences in policies and institutions that also differ between the two regions.

**Prescott (2004). Why Do Americans Work Much More than Europeans?, Quarterly Review of the Federal Reserve Bank of Minneapolis.

**Rogerson (2005). Structural Transformation and the Deterioration of European Labor Market Outcomes, mimeo Arizona State University

Ljungqvist, Lars and Thomas J. Sargent (1998). The European Unemployment Dilemma, Journal of Political Economy

Ljungqvist, Lars and Thomas Sargent (2006). Indivisible Labor and Its Supply Elasticity: Do Taxes Explain European Employment?, mimeo Stockholm School of Economics.

F. Guvenen, B Kuruscu and Serdar Ozkan (2012): “Taxation of Human Capital and Wage Inequality: A Cross-Country Analysis.”

*D. Acemoglu, P. Aghion, and G. Violante (2001), “Deunionization, Technical Change and Inequality,” Carnegie Rochester Conference Series on Public Policy 55 (December), 229-64.

F. Blau and L. Kahn (1996) “International Differences in Male Wage Inequality: Institutions versus Market Forces,” Journal of Political Economy 104 (August), 791-837.

D. Acemoglu (2003), “Cross-Country Inequality Trends,” Economic Journal 70 (April), 199-230.

V. Calibration

Browning, M., L. P. Hansen, and J. J. Heckman (1999): “Micro data and general equilibrium models,” in Handbook of Macroeconomics, ed. by J. B. Taylor, and M. Woodford.

Blundell Richard, and Tom MaCurdy (1999): “Labor Supply: A Review of Alternative Approaches,” in Handbook of Labor Economics, vol. 3, North Holland

Domeij David, and Martin Floden (2006): “The Labor-Supply Elasticity and Borrowing Constraints: Why Estimates are Biased,” Review of Economic Dynamics Imai S. and Micheal Keane (2004): “Intertemporal Labor Supply and Human Capital Accumulation,” International Economic Review.

Rogerson Richard, and Johanna Wallenius (2006): “Micro and Macro Elasticities in a Life Cycle Model with Taxes,” NBER wp 13017

Chang Yongsung and S. Kim (2006): “From Individual to Aggregate Labor Supply: A Quantitative Analysis Based on a Heterogeneous Agent Economy,” International Economic Review.

Guvenen, Fatih (2007): “Reconciling Conflicting Evidence on the Elasticity of Intertemporal Substitution: A Macreoconomic Perspective,” Journal of Monetary Economics. Rabin, Matthew (2000): “Risk Aversion and Expected-Utility Theory: A Calibration Theorem,“ Econometrica 68(5), 1281-1292, September 2000.