INTERGENERATIONAL PERSISTENCE OF INCOME: SOURCES AND POLICY
Carlos Urrutia and
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Carlos Urrutia: Universidad Carlos III de Madrid
Diego Restruccia: University of Toronto
No 365, Computing in Economics and Finance 2000 from Society for Computational Economics
Recent empirical studies show that the intergenerational persistence of income is much higher than previously thought. The objective of the paper is to account for this observation. Unlike models that rely on exogenous transmission of abilities or luck, we generate persistence endogenously through two channels: direct wealth bequests and investment in child's education in an environment with imperfect credit markets.We construct a dynastic overlapping generations model in which individuals live for two periods. Old agents decide how much to invest in their chidren's education and the amount of bequests (constrained to be non-negative). Agents face two types of idiosyncratic i.i.d. shocks: an ability shock; that we interpret as a broad measure of learning potential, and a wage shock representing career luck. We characterize a stationary equilibrium for this economy and choose parameter values to match relevant features of the U.S. economy, in particular the distributions of education, earnings, and income. We find that the model is able to account for around one third of the observed persistence in earnings and half of the persistence in income.
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