New version: June 2022
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.
An emerging consensus is that the Frisch elasticity of labor supply is small. This may reflect a lack of salience, inelastic preferences, or prevalence of frictions. Studying survey data collected during a tax holiday in Norway, when earnings were untaxed during a transition between tax systems, I report three findings. First, 80 percent of adults were aware of the tax holiday. Second, one-fifth of adults responded by working more. Third, frictions in adjusting working hours or non-working time are the reason for more than half of the non-responses. The findings support the long-held notion that labor supply choices are constrained.
Transitory Earnings Opportunities and Educational Scarring of Young Men
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Exploiting a tax reform that lowered income taxes to zero for a single year, I study the consequences of a transitory increase in the opportunity cost of schooling. Using a regression discontinuity design that compares teenagers above and below the compulsory schooling age, I document increased school dropout. There is a permanent loss in young men’s educational attainment but no effects on women. Earnings of male dropouts fall behind during early adulthood and they suffer substantial losses in lifetime earnings relative to the control group. In addition, dropouts suffer misfortune through slower career progression, less marriage, and reduced fertility. The results are consistent with misperceived returns to education, either due to dropouts underestimating returns or overvaluing immediate gains relative to future payoffs. My results imply that economic booms can have a ‘scarring effect’ on human capital, potentially reducing aggregate labor productivity permanently.
It Runs in the Family: Occupational Choice and the Allocation of Talent
with Mattias Almgren and John Kramer
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Children frequently grow up to work in the same jobs as their parents. Using unique data on worker skills and personality traits, and administrative data on the labor market outcomes of Swedish men, we study occupational choice and its impact on the allocation of talent. We document that sons are disproportionately more likely to follow into the same occupation as their fathers, across all skills and earnings levels. On average, sons are more likely to follow if their skills align with those of incumbents in their father’s occupation. Still, we find that a decline in a father’s occupation leads to less following, better skill match, and higher income. We estimate a general equilibrium Roy model with costly occupational choice and heterogeneous entry barriers depending on parental background. We find that these entry barriers lead to misallocation: Equalizing entry costs across workers leads occupational following to fall by half. However, this reallocation of workers increases intergenerational mobility and aggregate income only modestly, because when sorting on comparative advantage sons move to occupations similar to those of their fathers in terms of income and skill requirements. Our findings suggest that increasing intergenerational occupational mobility would bring limited efficiency gains.
Misperceptions about Interest Expenses
We document how indebted households systematically misperceive their interest expenses. Comparing actual third-party reported interest expenses of Swedish households with their survey responses, respondents on average think their interest expenses are 16 percent lower than they actually are. This bias is larger and more prominent among less cognitively-skilled and less-educated respondents, and among households with weaker balance sheets—more debt and less liquid savings. Using a consumption-savings model, we illustrate that even small but heterogeneous misperceptions about interest expenses can amplify household consumption sensitivity to transitory shocks to income or interest expenses, such as due to monetary policy tightening.
Review of Economic Studies, 2022. Vol. 89, Issue 3, p.1557-1592
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.
Economic Journal, 2021, Vol. 131, Issue 636, p. 1742-1771
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.
Journal of Monetary Economics, 2016. Vol. 78, , Issue 2, p. 50-66
with Rannveig Sigurdardottir
Media coverage: Centralbanking.com
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
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.
with Mattias Almgren and John Kramer
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).