The Effects of Biased Labor Market Expectations on Consumption, Wealth Inequality, and Welfare

Almut Balleer, Georg Duernecker, Susanne K. Forstner and Johannes Goensch

No 9326, CESifo Working Paper Series from CESifo

Abstract: Idiosyncratic labor risk is a prevalent phenomenon with important implications for individual choices. In labor market research it is commonly assumed that agents have rational expectations and therefore correctly assess the risk they face in the labor market. We analyse survey data for the U.S. and document a substantial optimistic bias of households in their subjective expectations about future labor market transitions. Furthermore, we analyze the heterogeneity in the bias across different demographic groups and we find that high-school graduates tend to be strongly over-optimistic about their labor market prospects, whereas college graduates have rather precise beliefs. In the context of a quantitative heterogenous agents life cycle model we show that the optimistic bias has a quantitatively sizable negative effect on the life cycle allocation of income, consumption and wealth and implies a substantial loss in individual welfare compared to the allocation under full information. Moreover, we establish that the heterogeneity in the bias leads to pronounced differences in the accumulation of assets across individuals, and is thereby a quantitatively important driver of inequality in wealth.

Keywords: subjective expectations; labor markets; consumption; asset accumulation; wealth inequality (search for similar items in EconPapers)
JEL-codes: D84 E21 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-dge, nep-lma and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Working Paper: The Effects of Biased Labor Market Expectations on Consumption, Wealth Inequality, and Welfare (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_9326

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