Labor income earned in Iceland in 1987 went untaxed. I use this episode to study labor supply responses to temporary wage changes. I construct a new population-wide dataset of earnings and working time from pay slips and use two identification strategies to estimate intensive and extensive margin Frisch elasticities of 0.37 and 0.10, respectively. Workers with the ability to adjust drive these average responses: extensive margin responses by young and close-to-retirement cohorts and intensive margin responses by workers in temporally flexible jobs. However, constrained workers take up secondary jobs, which contribute to one-tenth of the overall response. Importantly, married women with children and the wives of men in temporally inflexible jobs respond more strongly than other women do. Within families, wives respond more than do their husbands, who themselves respond negatively to their wives’ tax cuts. This is consistent with substitutability in nonmarket time. Overall, my results suggest that adjustment frictions reduce aggregate labor supply responses to tax cuts and can similarly explain differences in elasticities within and across countries.
We exploit a volcanic “experiment” to study the costs and benefits of geographic mobility. In our experiment, a third of the houses in a town were covered by lava. People living in these houses were much more likely to move away permanently. For the dependents in a household (children), our estimates suggest that being induced to move by the “lava shock” dramatically raised lifetime earnings and education. While large, these estimates come with a substantial amount of statistical uncertainty. The benefits of moving were very unequally distributed across generations: the household heads (parents) were made slightly worse off by the shock. These results suggest large barriers to moving for the children, which imply that labor does not flow to locations where it earns the highest returns. The large gains from moving for the young are surprising in light of the fact that the town affected by our volcanic experiment was (and is) a relatively high income town. We interpret our findings as evidence of the importance of comparative advantage: the gains to moving may be very large for those badly matched to the location they happened to be born in, even if differences in average income are small.
We examine the effect of monetary policy on household spending when households are indebted and interest rates on outstanding loans are linked to short-term interest rates. Using administrative data on balance sheets and consumption expenditure of Swedish households, we reveal the cash-flow transmission channel of monetary policy. On average, indebted households reduce consumption spending by an additional 0.23–0.55 percentage points in response to a one-percentage-point increase in the policy rate, relative to a household with no debt. We show that these responses are driven by households that have some or a large share of their debt in contracts where interest rates vary with short-term interest rates, such as adjustable-rate mortgages (ARMs), which implies that monetary policy shocks are quickly passed through to interest expenses.
Administrative data on monthly wages in Iceland during 1998–2010 provide new insight into nominal wage rigidity. Unlike the data used in previous work, ours have a higher frequency, minimal measurement error, and a long sample including a period of substantial macroeconomic instability. We find that the monthly frequency of nominal wage changes is 13 percent. Although nominal wage cuts are rare, their frequency rises following a large macroeconomic shock. Timing of wage changes is both time-dependent and state-dependent: we find evidence of synchronization of adjustment and contracts of fixed duration, but also that inflation and unemployment over the wage spell affect the timing of adjustment.
Research in Progress
Dropping Out to Work: The Cleansing Effect of Temporary Opportunities on Education Attainment
I study how a temporary increase in the opportunity cost of schooling affects educational attainment and subsequent labor market outcomes. Exploiting a salient tax reform that led to labor earnings not being taxed for a year and comparing individuals above and below compulsory schooling age, I document reduced enrollment and increased dropout from upper- secondary school. While some students eventually return to school there is a permanent loss in educational attainment of about one month, driven by dropout from academic tracks which are prerequisite for higher education.
Real Wage Persistence and Job Displacement in Recessions
Do tight labor market conditions have persistent effect on real wages and, if so, are higher wages associated with higher risk of layoff in recessions? This paper provides new answers to these two important questions. Using employer-employee data on wages and employment in Iceland prior to and during the Great Recession, I find that labor market conditions at the beginning and during employment spells have persistent effects on real wages. Furthermore, I find that this downward real wage rigidity has allocative consequences for employment. Workers that were hired at times of favorable labor market conditions and thus have higher wages face significantly higher probability of job loss in recessions. These results indicate that higher entry-level wages reflect cyclicality and downward persistence of rents rather than differences in human capital accumulation or match quality.
Policy Papers and Working Papers Not Intended for Publication
QMM: A Quarterly Macroeconomic Model of the Icelandic Economy
Central Bank of Iceland, Working Paper No. 71, December 2015 (with Ásgeir Daníelsson, Bjarni G. Einarsson, Magnús F. Gudmundsson, Svava J. Haraldsdóttir, Thórarinn G. Pétursson, Signý Sigmundardóttir, and Rósa Sveinsdóttir).
How "Natural" is the Natural Rate? Unemployment Hysteresis in Iceland