Kjetil Storesletten

Sustaining Fiscal Policy through Immigration

Using a calibrated general equilibrium overlapping generations model, which explicity accounts for differences between immigrants and natives, this paper investigates whether a reform of immigration policies alone could resolve the fiscal problems associated with the aging of the baby boom generation. Such policies are found to exist and are characterized by an increased inflow of working‐age high‐and medium‐skilled immigrants. One particular feasible policy involves admitting 1.6 million 40–44‐year‐old high‐skilled immigrants annually. These findings are illustrated by computing the discounted government gain of admitting additional immigrants, conditional on their age and skills.

Cyclical Dynamics in Idiosyncratic Labor Market Risk

Is individual labor income more risky in recessions? This is a difficult question to answer because existing panel data sets are so short. To address this problem, we develop a generalized method of moments estimator that conditions on the macroeconomic history that each member of the panel has experienced. Variation in the cross‐sectional variance between households with differing macroeconomic histories allows us to incorporate business cycle information dating back to 1930, even though our data do not begin until 1968. We implement this estimator using household‐level labor earnings data from the Panel Study of Income Dynamics. We estimate that idiosyncratic risk is (i) highly persistent, with an annual autocorrelation coefficient of 0.95, and (ii) strongly countercyclical, with a conditional standard deviation that increases by 75 percent (from 0.12 to 0.21) as the macroeconomy moves from peak to trough.

The Macroeconomic Implications of Rising Wage Inequality in the United States

In recent decades, American workers have faced a rising college premium, a narrowing gender gap, and increasing wage volatility. This paper explores the quantitative and welfare implications of these changes. The framework is an incomplete-markets life cycle model in which individuals choose education, intrafamily time allocation, and savings. Given the observed history of the U.S. wage structure, the model replicates key trends in cross-sectional inequality in hours worked, earnings, and consumption. Recent cohorts enjoy welfare gains, on average, as higher relative wages for college graduates and for women translate into higher educational attainment and a more even division of labor within the household.

The Welfare Cost of Business Cycles Revisited: Finite Lives and Cyclical Variation in Idiosyncratic Risk

This paper investigates the welfare costs of business cycles in a heterogeneous agent, overlapping generations economy which is distinguished by idiosyncratic labor market risk. Aggregate variation arises both in terms of aggregate productivity shocks and countercyclical variation in the volatility of idiosyncratic shocks. Based on both aggregate data and microeconomic data from the Panel Study on Income Dynamics, we find the welfare benefits of eliminating aggregate variation to be large an order of magnitude larger than those originally documented by Lucas (1987). The key difference is countercyclical variation in idiosyncratic risk, which both amplifies the welfare cost of aggregate productivity shocks and imposes a cost of its own. The magnitude of these effects increases non-linearly in risk aversion. Our results support the increasingly popular notion that distributional effects are an important aspect of understanding the welfare cost of business cycles.

Democratic public good provision

This Paper analyses an overlapping generation model of public good provision under repeated voting. The public good is financed through age-dependent taxation that distorts human capital investment. Taxes redistribute income both across different skill groups and across generations. We contrast the political equilibria with the Ramsey allocation, and analyse the sources of inefficiency. The political equilibria can feature both under- and over-provision of public good, as well an inefficient life-cycle profile of taxes.

Equilibrium Unemployment Insurance

In this paper, we incorporate a positive theory of unemployment insurance into a dynamic overlapping generations model with search-matching frictions and on-the-job learning-by-doing. The model shows that societies populated by identical rational agents, but differing in the initial distribution of human capital across agents, may choose very different unemployment insurance levels in a politico-economic equilibrium. The interaction between the political decision about the level of the unemployment insurance and the optimal search behavior of the unemployed gives rise to a self-reinforcing mechanism whichmay generate multiple steady-state equilibria. In particular, a European-type steady-state with high unemployment, low employment turnover and high insurance can co-exist with an American-type steady-state with low unemployment, high employment turnover and low unemployment insurance. A calibrated version of the model features two distinct steady-state equilibria with unemployment levels and duration rates resembling those of the U.S. and Europe, respectively.

On the Optimal Timing of Capital Taxes

For many kinds of capital, depreciation rates change systematically with the age of the capital. Consider an example that captures essential aspects of human capital, both regarding its accumulation and its depreciation: a worker obtains knowledge in period 0, then uses this knowledge in production in periods 1 and 2, and thereafter retires. Here, depreciation accelerates: it occurs at a 100% rate after period 2, and at a lower (perhaps zero) rate before that. The present paper analyzes the implications of non-constant depreciation rates for the optimal timing of taxes on capital income. The main finding is that under natural assumptions, the path of tax rates over time must be oscillatory. Oscillatory tax rates are optimal when depreciation rates accelerate with the age of the capital (as in the above example), and provided that the government can commit to the path of future tax rates but cannot apply different tax rates in a given year to different vintages of capital.

From Wages to Welfare: Decomposing Gains and Losses from Rising Inequality *

This paper offers a critical evaluation of the large literature that studies the welfare consequences of the recent shift in the wage structure in the United States. Welfare calculations based on changes in the empirical distributions of consumption and hours worked – analyzed through the lens of a social welfare function– yield welfare losses on the order of two percent of lifetime consumption. However, two key components of the shift in the wage structure – the growth in the skill premium and the rise in wage volatility – can potentially generate welfare gains as individuals adjust their education and labor supply decisions. Quantifying the importance of these channels of adjustment requires a structural model. In our model-based calculations, under a plausible calibration, we find welfare gains exceeding one percent of lifetime consumption.

Asset Prices and Intergenerational Risk Sharing { the Role of Idiosyncratic Earnings Shocks ⁄

Abstract In their seminal paper, Rajnish Mehra and Edward Prescott (1985) were the first among many subsequent authors to suggest that non-traded labor-market risk may provide a resolution to the equity premium puzzle. The most direct demonstration of this was Constantinides and Duffie (1996) , who showed that, under certain conditions, cross-sectionally uncorrelated unit root shocks that become more volatile during economic contractions can resolve the puzzle. We examine the robustness of this to life-cycle effects. Retired people, for instance, do not face labor-market risk. If we incorporate them, to what extent will the equity premium be resurrected? Our answer is “not very much.” Our model, with realistic life-cycle features, can still account for about 75 percent of the average equity premium and the Sharpe ratio observed on the U.S. stock market.

DYNAMIC POLITICAL CHOICE IN MACROECONOMICS

We analyze positive theories of redistribution, social insurance and public good provision in a dynamic macroeconomic framework. Political outcomes are determined via repeated voting and driven by a conflict of interests between agents. Voters and politicians rationally forecast the impact of current political choices on future political and economic outcomes. The theory is consistent with large differences in the size of governments across societies. These need not rely on intrinsic differences in preferences or technology, but may be driven by self-fulfilling expectations about the robustness of the welfare state. (JEL: D72, E62, H11, H31, P16) Copyright (c) 2003 The European Economic Association.