Looking at Recessions through a Different Lens

By Wiczer, David | Regional Economist, October 2014 | Go to article overview

Looking at Recessions through a Different Lens


Wiczer, David, Regional Economist


A recession can be many things to many people, and this is precisely the insight of new research from economists Fatih Guvenen, Serdar Ozkan and Jae Song. Though the point seems trivial, their focus on differential impacts in the discussion of business cycles is relatively new. The Keynesian tradition described recessions in terms of declines in aggregate demand, analyzing the movement of statistics that describe the economy as a whole. Most of macroeconomic thinking followed suit. For instance, a recession came to be defined roughly as anytime that gross domestic product (GDP) declines for two consecu- tive quarters. But what is happening under the surface to the individuals who make up aggregate demand, those whose individual incomes comprise GDP?

Ten years ago, Kjetil Storesletten, Chris Telmer and Amir Yaron estimated in an influential paper that recessions had a very large and disparate impact on those who live through them; people's income trajec- tories diverge almost three times as much as during good times. Following from this and other related research, there is a popular conception that (a) recessions are times when the variance of earnings changes increases-some income trajectories fall more and others rise more than during peri- ods of stable growth, and (b) these shocks affect the bottom 99 percent of the popula- tion much more than the top 1 percent of earners. However, the research this year by Guvenen, Ozkan and Song challenges both of these perceptions. Using far-more complete data than was previously avail- able, the authors found instead that (a) it is the skewness of labor income that is affected during recessions-some people experience very large, negative changes, but fewer are set on positive trajectories, and (b) the high- est earners are, by some measures, the most affected by recessions.

In the past, most of the important research on the volatility of individuals' earnings has used data from self-reported income in relatively small surveys. This type of data has a number of drawbacks. Most obviously, the income is self-reported, hence, subject to respondent-side error. Also, because the surveys are relatively small, estimates made from even smaller subsets of this data are more prone to errors. More-recent research studies have used new, more precise data from either income tax or Social Security databases. This type of administrative data in the U.S. is largely free of reporting error; furthermore, given the very large sample sizes, the data can be divided into innumerable subsets without seriously compromising the accuracy of estimates.

In this article, we focus primarily on research from Guvenen, Ozkan and Song about earnings risk using Social Security data on individual earnings histories. In particular, we look at how recessions affect the distribution of changes to earnings. During recessions, there are more earn- ings losses than during good times, i.e., the distribution skews downward. These income losses are even more likely among the prerecession poor. On the other side of the distribution, high earners also experience recessions strongly, as the fraction of earn- ings lost by someone in the top 1 percent is as much as double the percentage loss of the average worker. We also look at how these trends have changed in different recessions since the early 1980s.

Earnings Risk

Earnings risk refers to unanticipated changes in one's earnings, what are often called "shocks" in economists' jargon. People may be laid off or promoted, or their earnings are simply not adjusted to keep up with inflation. We say risk rises when these changes spread out, when there are fewer people with stable incomes and when more people experience very positive or very negative changes; statistically, an increase in risk can correspond to an increase in the variance of changes.

Earnings risks are ever present, but reces- sions are times when the unemployment rate rises, fewer people switch to better-pay- ing jobs1 and recent college graduates have more difficulty finding good jobs. …

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