A retrospective on Friedman's theory of permanent income

Friedman's book on the Óƒonsumption FunctionÔ is one of the great works of Economics demonstrating how the interplay between theoretical ideas and data analysis could lead to major policy implications. We present a short review of Friedman's Permanent Income Hypothesis, the origins of the idea and its theoretical foundations. We give a brief overview of its influence in modern economics and discuss some relevant empirical results and the way they relate to the original approach taken by Friedman.Friedman, consumption function, permanent income hypothesis

Education Subsidies and School Drop-Out Rates

Education, School

Active labour market policy vs employment tax credits: lessons from recent UK reforms

Many welfare-to-work programs in both North America and Europe are directed at making work pay for the low skilled. This paper identifies two alternative policies that are motivated by this same objective – active labour market programs that involve wage subsidies together with improved job matching; and earned income tax credits that supplement wages for working low-income families. Although sharing similar concerns over labour market incentives for low skilled workers, these alternative policies typically differ in many important ways. We present an evaluation of the impacts of two such recent programs designed to enhance the labour market attachment of low-wage workers in the UK. These programs have many features in common and are similar to many policy proposals in Europe and North America. The evaluation of the UK reforms brings empirical evidence into the debate on the effectiveness of these programs and is used to assess what aspects of their design work well and what aspects could be improved.welfare reform; tax credits; wage subsidies; labour supply

Moment conditions for dynamic panel data models with multiplicative individual effects in the conditional variance

Moment conditions are derived for dynamic linear panel data models with linear individual specific effects in the mean and multiplicative individual effects in the conditional ARCH type variance function. The relation and correlation between the linear and multiplicative effects are unrestrained. Moment conditions are derived for non-autocorrelated error processes, MA(q) processes, and for models that allow for time varying parameters on both the linear mean effects and multiplicative variance effects. The small sample performance of a GMM estimator is investigated in a Monte Carlo simulation study.

Labour supply and taxes

In this paper we provide an overview of the literature relating labour supply to taxes and welfare benefits with a focus on presenting the empirical consensus. We begin with a basic continuous hours model, where individuals have completely free choice over their hours of work. We then consider fixed costs of work, the complications introduced by the benefits system, dynamic aspects of labour supply and we place the analysis in the context of the family. The key conclusion of this work is that in order to estimate the impact of tax reform and be able to generalise results, a structural approach that takes account of many of these issues is desirable. We then discuss the 'new Tax Responsiveness' literature which uses the response of taxable income to the marginal tax rate as a summary statistic of the behavioural response to taxation. Underlying this approach is the unsatisfactory nature of using hours as a proxy for labour effort for those with high levels of autonomy on the job and who already work long hours, such as the self employed or senior executives. After discussing relevant theory we then provide a summary of empirical estimates and the methodology underlying the studies. Our conclusion is that hours of work are relatively inelastic for men, but are a little more responsive for married women and lone mothers. On the other hand, participation is quite sensitive to taxation and benefits for women. Within this paper we present new estimates form a discrete participation model for both married and single men based on the numerous reforms over the past two decades in the UK. We find that the participation of low education men is somewhat more responsive to incentives than previously thought. For men with high levels of education, participation is virtually unresponsive; here the literature on taxable income suggests that there may be significant welfare costs of taxation, although much of this seems to be a result of shifting income and consumption to non-taxable forms as opposed to actual reductions in work effort.Labour Supply, Income taxation, Welfare Benefits, Tax Credits, Incentive Effects

Earnings, consumption and lifecycle choices

We discuss recent developments in the literature that studies how the dynamics of earnings and wages affect consumption choices over the life cycle. We start by analyzing the theoretical impact of income changes on consumption - highlighting the role of persistence, information, size and insurability of changes in economic resources. We next examine the empirical contributions, distinguishing between papers that use only income data and those that use both income and consumption data. The latter do this for two purposes. First, one can make explicit assumptions about the structure of credit and insurance markets and identify the income process or the information set of the individuals. Second, one can assume that the income process or the amount of information that consumers have are known and tests the implications of the theory. In general there is an identification issue that is only recently being addressed, with better data or better "experiments". We conclude with a discussion of the literature that endogenize people's earnings and therefore change the nature of risk faced by households.

Intra-household Welfare

In this paper we develop an approach to measuring inequality and poverty that recognizes the fact that individuals within households may have both different preferences and differential access to resources. We argue that a measure based on estimates of the sharing rule is inadequate as an approach that seeks to understand how welfare is distributed in the population because it ignores public good and the allocation of time to market work, leisure and household production. We develop a money metric measure of welfare that accounts for public goods (by using personalized prices) household production and for the allocation of time

Income variance dynamics and heterogenity

Recent theoretical work has shown the importance of measuring microeconomic uncertainty for models of both general and partial equilibrium under imperfect insurance. In this paper the assumption of i.i.d. income innovations used in previous empirical studies is removed and the focus of the analysis placed on models for the conditional variance of income shocks, that is related to the approporiate measure of risk emphasized by the theory. We first discriminate amongst various models of earnings determination that separate income shocks into idiosyncratic transitory and permanent components. We allow for education-specific differences in the stochastic process for earnings and for measurement error. The conditional variance of the income shocks is then modelled as a parsimonious autoregressive process with both observable and unobserved heterogeneity. The empirical analysis is conducted on data drawn from the 1967-1991 Panel Study of Income Dynamics.

Financial constraints and company investment

The question we address in this paper is whether the investment spending of at least some firms is affected by the availability of internally generated finance (retained earnings), reflecting some constraint on the ability of these firms to raise external finance (debt or new equity) for investment. The opposing view is that the cost at which investment funds can be obtained, taken to be independent of the amount invested, is the only financial consideration that matters in the determination of investment. This is an old question in economics, which has been the subject of several official inquiries as well as a large body of academic research. The answer to this question has a number of important implications. Profits are highly cyclical, so if investment depends directly on the availability of profits then investment spending will be more sensitive to fluctuations in economic activity than would otherwise be the case. This could be an important factor in the propagation of business cycles. If post-tax profits help to determine investment spending then the impact of company taxes on investment will be more complicated than is often assumed. In particular, the average tax rate will influence the level of investment spending, in addition to the impact of taxes on the cost of capital, and any increase in the total revenue raised from corporation tax could have a directly adverse impact on business investment. There may also be an incentive for firms with available internal funds to take over firms whose investment spending is constrained, resulting in take-over activity that would otherwise be inefficient. To the extent that financial constraints on investment spending are attributable to imperfections in capital markets or to market failures, there may also be some motivation for policy measures designed to reduce these impacts, if financial constraints are found to be pervasive.

Econometric methods for research in education

This paper reviews some of the econometric methods that have been used in the economics of education. The focus is on understanding how the assumptions made to justify and implement such methods relate to the underlying economic model and the interpretation of the results. We start by considering the estimation of the returns to education both within the context of a dynamic discrete choice model inspired byWillis and Rosen (1979) and in the context of the Mincer model. We discuss the relationship between the econometric assumptions and economic behaviour. We then discuss methods that have been used in the context of assessing the impact of education quality, the teacher contribution to pupils' achievement and the effect of school quality on housing prices. In the process we also provide a summary of some of the main results in this literature.