DP3628 Anticipated and Unanticipated Wage Changes, Wage Risk, and Intertemporal Labour Supply

Author(s): Luigi Pistaferri
Publication Date: November 2002
Keyword(s): labour supply, subjective expectations
JEL(s): D91, J22
Programme Areas: Labour Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=3628

We address the question of how labour supply responds to anticipated wage growth, unanticipated wage growth, and wage risk. We use the 1989-93 panel section of the Bank of Italy SHIW, which collects individual-based quantitative expectation of future wage growth. The use of subjective expectations has several advantages. First, subjective expectations provide information on the evolution and riskiness of future wages that the econometrician may never hope to observe. Second, they allow to control directly for the forecast error, thus avoiding inconsistency in short panels. Finally, controlling for anticipated and unanticipated wage changes avoids the need of specifying instruments for the growth rate of wages, which is usually hard to predict. We find that the intertemporal elasticity of substitution is precisely estimated and slightly larger than previous micro estimates. A parametric permanent innovation in wages impacts positively the rate of growth of labour supply. The impact of wage risk is consistent with the theory, but of negligible magnitude.