The authors assess whether the sudden large losses in household wealth due to recent declines in stock and home values have significantly affected the U.S. labor market. They find that the overall labor force participation rate would be 0.7 percentage points lower were it not for the declines in the values of stocks and houses over the 2006–10 period.Labor mobility ; Wealth ; Labor market ; Households

David Benson

Eric French

English

Research Papers in Economics

How do sudden large losses in wealth  
affect labor force participation?
by Eric French, senior economist, and David Benson, associate economist
The authors assess whether the sudden large losses in household wealth due to recent 
declines in stock and home values have significantly affected the U.S. labor market. They 
find that the overall labor force participation rate would be 0.7 percentage points lower 
were it not for the declines in the values of stocks and houses over the 2006–10 period.
Chicag­ o­Fed­Letter
ESSAYS ON ISSUES                                               THE FEDERAL RESERVE BANK  JANUARY 2011
  OF CHICAGO                                                          NUMBER 282
1. Labor force participation and employment, by age, 1990–2009
Source: Authors’ calculations based on data from the U.S. Bureau of Labor Statistics from Haver Analytics.
1990 ’92 ’94 ’96 ’98 2000 ’02 ’04 ’06 ’08
54
56
58
60
62
64
66
68
70
A. Labor force participation rate B. Share employed
percent percent
1990 ’92 ’94 ’96 ’98 2000 ’02 ’04 ’06 ’08
50
52
54
56
58
60
62
64
66
16 and older 55–64
There­have­been­many­news­stories­
about­people­in­the­U.S.­delaying­re-
tirement­to­work­an­extra­year­or­two­
to­recoup­large­losses­on­their­invest-
ments­in­stocks­and­housing.1­In­this­
Chicago Fed Letter,­we­assess­whether­such­
stories­are­isolated­incidents­or­whether­
the­sudden­declines­in­asset­prices,­or­
wealth­shocks,­have­significantly­affected­
the­labor­market.­
Quantifying­the­effects­of­recent­wealth­
shocks­helps­explain­current­(and­fore-
cast­future)­variation­in­labor­force­partici-
pation,­employment,­and­unemployment.­
Consider­a­worker­near­retirement­age.­
If­the­value­of­her­stocks­or­home­un-
expectedly­falls­by­a­significant­amount,­
this­reduced­wealth­might­be­equivalent­
to­years­of­income­from­wages.­It­is­
reasonable,­then,­that­such­a­worker­
might­leave­the­work­force­later­than­
she­had­planned­in­order­to­replace­that­
lost­wealth.­In­such­a­scenario,­years­of­
additional­wage­income­would­be­nec-
essary­to­afford­the­retirement­lifestyle­
she­had­desired­before­the­sudden­loss­
in­wealth.­Knowing­the­magnitude­of­
this­effect­from­changes­in­wealth­nation-
wide­is­valuable­for­labor­forecasts.
On­the­surface,­labor­force­participation­
statistics­for­older­individuals­seem­con-
sistent­with­anecdotes­about­delayed­
retirements.­Labor­force­participation­
for­most­age­groups­has­been­falling,­
whereas­it­has­been­rising­for­those­
aged­55–64­in­the­wake­of­the­stock­
and­housing­market­busts.­Panel­A­of­
figure­1­shows­that­the­labor­force­par-
ticipation­rate­for­everyone­aged­16­and­
older­fell­from­66.0%­in­2005­to­65.4%­
in­2009,­whereas­the­participation­rate­
for­those­aged­55–64­rose­from­62.9%­
to­64.9%.­Although­employment­rates­
of­those­aged­55–64­have­fallen­in­the­
past­two­years,­presumably­on­account­
of­stagnant­wages­and­fewer­employ-
ment­opportunities,­panel­B­of­figure­1­shows that the decline for them has 
been smaller than for other age groups.
The general upward trend in labor force 
participation for older individuals is not 
a new phenomenon. Since the trend has 
persisted from the early 1990s onward, 
the role of wealth shocks in driving these 
movements is not clear. Improving health 
and life spans, as well as changes in pen-
sions and the Social Security rules, have 
all likely encouraged delayed retirements. 
For these reasons, we estimate the dis-
tribution of wealth shocks for older 
households and combine this value with 
estimates of the effect of changes in 
wealth on labor supply to infer the 
likely effect of recent wealth shocks on 
aggregate labor supply. We find that the 
aggregate labor force participation rate 
would be 0.7 percentage points lower 
were it not for the recent losses in house-
hold wealth. The effect is larger for 
those near retirement: For those aged 
51–65, the labor force participation rate 
would be 2.9 percentage points lower.
Declines in wealth 
We first estimate the distribution of 
wealth shocks faced by different house-
holds over the past five years. From 
January 2006 through August 2010, 
returns from both stocks and housing 
were well below their averages over the 
period 1960–2005. The annual real re-
turn from stocks was 5.4% and the an-
nual real return from housing was 5.6% 
over the 1960–2005 period.2  The re-
turns from stocks and housing were 
much lower over the 2006–10 period. 
Figure 2 illustrates stock and housing 
returns over time.    
We assume that households in 2006 ex-
pected that asset prices would continue 
to grow at their 1960–2005 averages. 
Thus, the expected cumulative return 
over the 2006–10 period for stocks was 
(1 + 0.054)5 = 1.30; and this return for 
housing was 1.32. The realized cumu-
lative return, however, turned out to 
be 0.78 for stocks and 1.00 for housing 
(house prices fell over the 2006–10 
period, but their declines were offset 
by the returns from the service flow from 
housing, i.e., the value of rents that home-
owners need not pay).3 Thus, for every 
$1 in stock held in 2006, households 
anticipated an increase to $1.30 by 2010; 
but that $1 in stock turned out to be 
worth $0.78, which amounts to a pre-
dicted wealth loss of $0.52. This pre-
dicted wealth loss is $0.32 for housing.
To estimate how these wealth shocks 
have affected the portfolios of those 
approaching retirement, we use the 
2. Returns from stocks and housing, 1960–2010
Notes: For panel A, year-end to year-end stock returns are computed and plotted. See notes 2 and 3 for details on how housing 
returns are computed for panel B. All returns in both panels are adjusted for inflation.
sources: Authors’ calculations based on data from the University of Chicago Booth School of Business, Center for Research 
in Security Prices (CRSP) stock index; Wilshire Associates Inc., Wilshire 5000 Total Market Index; U.S. Bureau of Economic 
Analysis, national income and product accounts; Federal Housing Finance Agency, House Price Index; U.S. Bureau of Labor 
Statistics, Consumer Price Index, owners’ equivalent rent component; French, Doctor, and Baker (2007); and Haver Analytics.
A. Returns from stocks B. Returns from housing
annual percent change annual percent change
Stock returns
Average stock return, 1960–2005
Average stock return, 2006–10
1960 ’70 ’80 ’90 2000 ’10
–60
–40
–20
0
20
40
60
Housing returns
Average housing return, 1960–2005
Average housing return, 2006–10
1960 ’70 ’80 ’90 2000 ’10
–5
0
5
10
15
University of Michigan’s Health and 
Retirement Study (HRS). The HRS is a 
nationally representative sample of 
noninstitutionalized individuals aged 
51 and older. We ignore the effect of 
changes in asset prices on the labor 
supply of younger workers for two rea-
sons. First, younger people tend to have 
less wealth than those over 50, and so 
they have less wealth to lose. Second, 
younger people are likely further from 
retirement. Cheng and French4 show 
that for these two reasons, those younger 
than 51 are unlikely to adjust their la-
bor supply much in response to asset 
price changes.
The HRS asks its respondents detailed 
questions about their household wealth 
in stocks, housing, and businesses.5 Of 
those aged 51–65 in 2006, 53% of their 
wealth was in housing, 23% in stocks, and 
13% in businesses.6 These three asset 
groups all suffered large price declines 
over the period 2006–10. The HRS like-
ly understates total stock market wealth 
among the richest people. Examining 
data from the Federal Reserve Board’s 
Flow of Funds Accounts of the United States, 
we show this potential understatement: 
In the national aggregate, 39% of house-
hold wealth is from housing, 34% from 
stocks, and 14% from businesses. Part 
of this difference is likely due to the 
fact that portfolios of those aged 51–65 
are different than those of other ages, 
but part of this is likely due to the under-
reporting of stock market wealth. Using 
the HRS data and the predicted wealth 
loss described previously, we can calcu-
late the wealth lost for each member of 
the HRS sample by taking the amount 
of wealth held in each asset class in 2006 
and multiplying that by the likely wealth 
loss (over the 2006–10 period) per dollar 
held in that asset in 2006.
The HRS has not only data on asset hold-
ings but also data on earnings. Thus, we 
can compare the wealth loss to their earn-
ings if they were still working in 2010. 
Figure 3 shows that, relative to their annual 
earnings, 51.7% of those aged 51–65 lost 
at least one year’s worth of earnings and 
6.6% lost at least eight years’ worth of 
earnings over the period 2006–10.7 3. Predicted wealth shock effect on labor force in 2010 
    Mean
Employment rate (percent)  55.1
Decline in labor force participation (percentage points)  2.9
Years’ worth of earnings lost  2.9
Share of sample with earnings loss worth at least (percent)
  1 year  51.7
  3 years  20.0
  8 years  6.6
NoteS: The HRS surveys noninstitutionalized individuals aged 51 and older. The values 
here are calculated for those aged 51–65. The wealth shock effect over the 2006–10 period 
is shown.
SourceS: Authors’ calculations based on data from the University of Michigan, Institute for 
Social Research, Health and Retirement Study (HRS); and Haver Analytics.
Charles­L.­Evans, President  ; Daniel­G.­Sullivan,­
Executive Vice President and Director of Research; 
Spencer­Krane, Senior Vice President and Economic 
Advisor ; David­Marshall,­Senior Vice President, financial 
markets group  ; Daniel­Aaronson,­Vice President, 
microeconomic policy research; Jonas­D.­M.­Fisher, 
Vice President, macroeconomic policy research; Richard­
Heckinger,­Assistant Vice President, markets team; 
Anna­Paulson,­Vice President, finance team; William­A.­
Testa,­Vice President, regional programs, and Economics 
Editor ; Helen­O’D.­Koshy­and­Han­Y.­Choi, Editors    ; 
Rita­Molloy­and­Julia­Baker, Production Editors  ; 
Sheila­A.­Mangler, Editorial Assistant.   
Chicago Fed Letter­is­published­by­the­Economic­
Research­Department­of­the­Federal­Reserve­Bank­
of­Chicago.­The­views­expressed­are­the­authors’­
and­do­not­necessarily­reflect­the­views­of­the­
Federal­Reserve­Bank­of­Chicago­or­the­Federal­
Reserve­System.­
©­2011­Federal­Reserve­Bank­of­Chicago­­
Chicago Fed Letter­articles­may­be­reproduced­in­
whole­or­in­part,­provided­the­articles­are­not­­
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and­provided­the­source­is­appropriately­credited.­
Prior­written­permission­must­be­obtained­for­
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Letter­articles.­To­request­permission,­please­contact­
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Letter and­other­Bank­publications­are­available­
at­www.chicagofed.org.
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ISSN­0895-0164
Effect of changes in wealth  
on labor supply
We­next­provide­calibrations­showing­the­
predicted­effect­of­these­wealth­shocks­
on­the­aggregate­labor­force­participa-
tion­rate.­Identifying­the­effect­of­changes­
in­wealth­on­labor­supply­is­difficult­
because­those­who­enjoy­working­will­
work­longer,­attaining­higher­wealth.­­
Fortunately,­however,­there­are­several­
studies­of­the­labor­supply­response­
for­workers­with­unanticipated­gains­
in­wealth.­For­example,­Cheng­and­
French­(2000)­review­studies­of­the­labor­
supply­response­of­those­receiving­an­
inheritance­or­winning­the­lottery.­
More­recent­studies­have­estimated­the­
labor­supply­response­to­the­stock­mar-
ket­run-up­in­the­1990s­and­the­stock­
market­rundown­in­the­2000s.8­All­of­
these­studies­have­shown­that­people­
reduce­their­work­hours­after­an­unan-
ticipated­wealth­gain.­Cheng­and­French­
(2000)­suggest­that­the­results­from­
the­inheritance­and­lottery­studies­are­
consistent­with­the­following­relation-
ship­between­wealth­shocks­and­labor­
force­participation:
( ) ( )
( ) ( )
( ) ( )
0.010 if 8
0.032 0.006 if 8 30,
0.152 0.002 if­ 30
i i
i
i i
i i
A A
Y Y
A A
LFPR
Y Y
A A
Y Y
D D
´ <
D D
-D = + ´ £ <
D D
+ ´ ³
ì ï ï ï ï ï ï ï ï í ï ï ï ï ï ï ï ï î
and­2010,­divided­by­
her­earnings.­We­then­
average­the­predicted­
change­in­labor­force­
participation­over­all­
members­of­the­sam-
ple.­In­other­words,­
the­equation­states­
that­an­individual­who­
lost­one­year’s­worth­
of­income­over­the­
2006–10­period­is­1%­
more­likely­to­be­in­
the­labor­force­in­2010;­
an­individual­who­lost­
two­years’­worth­of­in-
come­is­2%­more­likely­to­be­in­the­labor­
force;­and­so­on.­­
Conclusion
Based­on­this­equation,­the­U.S.­labor­
force­participation­rate­among­those­
aged­51–65­would­be­lower­by­2.9­per-
centage­points­were­it­not­for­the­de-
clines­in­asset­prices­over­the­2006–10­
period.­Furthermore,­this­age­group­
represents­23.4%­of­the­population­
aged­16­and­older.­So,­our­best­guess­is­
that­were­it­not­for­the­declines­in­asset­
prices,­the­overall­labor­force­partici-
pation­rate­would­be­lower­by­0.7­per-
centage­points­(2.9­×­0.234­=­0.7).
That­said,­there­are­a­few­caveats­to­con-
sider.­Our­choice­of­2006­as­the­base­
year­is­somewhat­arbitrary,­and­2006­was­
a­fairly­good­year­for­asset­prices.­For­
example,­if­we­began­in­2007­and­ended­
in­2010,­we­would­generate­slightly­larg-
er­wealth­losses.­Also,­the­HRS­wealth­
data­are­good,­but­not­perfect.­By­using­
the­HRS­data,­we­likely­understate­the­
total­amount­of­stock­wealth­for­older­
individuals­and­thus­the­stock­market­
losses­for­them,­as­we­mentioned­earlier.­
Finally,­it­is­likely­that­those­younger­than­
51­and­those­older­than­65­had­some­
labor­supply­responses­to­the­asset­price­
declines.­Given­these­caveats,­it­is­very­
likely­that,­even­if­our­assumed­behavior-
al­responses­to­the­recent­wealth­shocks­
are­correct,­we­are­actually­understating­
the­wealth­losses­in­the­economy­and­
thus­the­labor­supply­responses.­ where­
i
A
Y
æ ö D ÷ ç ÷ ç ÷ ç è ø is­the­unexpected­wealth­
shock­for­an­individual­between­2006­
1­See,­e.g.,­Steven­Greenhouse,­2008,­“Working­
longer­as­jobs­contract,”­New York Times,­
October­22,­available­at­www.nytimes.com/­
2008/10/23/business/retirement/­
23SQUEEZE.html.
2­To­measure­the­return­from­housing,­we­
use­the­methods­described­in­Eric­French,­
Phil­Doctor,­and­Olesya­Baker,­2007,­“Asset­
rundown­after­retirement:­The­importance­
of­rate­of­return­shocks,”­Economic Perspectives,­
Federal­Reserve­Bank­of­Chicago,­­Vol.­31,­
No.­2,­Second­Quarter,­pp.­48–65.­
3­We­calculate­housing­returns­by­using­the­
Federal­Housing­Finance­Agency,­or­FHFA­
(formerly­the­Office­of­Federal­Housing­
Enterprise­Oversight),­House­Price­Index.­
These­returns­are­augmented­to­account­
for­service­flows­due­to­housing­by­using­the­
methods­described­in­French,­Doctor,­and­
Baker­(2007).­Using­other­methods­described­
in­that­article,­we­also­derive­returns­to­
liquid­assets­and­business­wealth.­We­adjust­
all­returns­for­inflation.
4­Ing-Haw­Cheng­and­Eric­French,­2000,­“The­
effect­of­the­run-up­in­the­stock­market­
on­labor­supply,”­Economic Perspectives,­
Federal­Reserve­Bank­of­Chicago,­­Vol.­24,­
No.­4,­­Fourth­Quarter,­pp.­48–65.
5­The­HRS­has­data­on­the­value­of­housing­
and­real­estate,­autos,­liquid­assets­(which­
include­money­market­accounts,­savings­
accounts,­and­Treasury­bills),­individual­retirement­accounts­(IRAs),­Keogh­plans,­
stocks,­farms­and­businesses,­mutual­funds,­
bonds,­and­other­assets­and­investment­
trusts.­We­measure­wealth­as­the­sum­of­
all­these­assets,­less­debts,­and­exclude­
wealth­from­defined­benefit­pensions­and­
Social­Security.­We­assume­that­60%­of­
defined­contribution­pension­wealth­is­
invested­in­stocks­and­the­remainder­is­
invested­in­bonds.
6­We­calculate­these­shares­as­mean­wealth­
in­a­given­asset­class­for­all­households­in­
the­sample­and­dividing­by­mean­net­worth­
for­all­households­in­the­sample.
7­For­households­with­both­a­husband­and­a­
wife,­we­divide­household­wealth­equally­
between­the­two­spouses.
8­There­are­several­recent­papers­that­esti-
mate­the­labor­supply­response­to­stock­
market­fluctuations.­See,­e.g.,­Julia­Lynn­
Coronado­and­Maria­Perozek,­2003,­“Wealth­
effects­and­the­consumption­of­leisure:­Re-
tirement­decisions­during­the­stock­market­
boom­of­the­1990s,”­Finance­and­Economics­
Discussion­Series,­Board­of­Governors­of­
the­Federal­Reserve­System,­working­paper,­
No.­2003-20,­May;­Courtney­C.­Coile­and­
Phillip­B.­Levine,­2006,­“Bulls,­bears,­and­
retirement­behavior,”­Industrial and Labor 
Relations Review,­Vol.­59,­No.­3,­April,­pp.­
408–429;­and­Michael­D.­Hurd,­Monika­
Reti,­and­Susann­Rohwedder,­2009,­“The­
effect­of­large­capital­gains­or­losses­on­
retirement,”­in­Developments in the Economics 
of Aging,­David­A.­Wise­(ed.),­Chicago:­
University­of­Chicago­Press,­pp.­127–163.­
These­works­find­that­labor­supply­does­
respond­to­stock­market­fluctuations,­al-
though­the­responses­appear­smaller­than­
those­in­Cheng­and­French­(2000).­

How do sudden large losses in wealth affect labor force participation?

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How do sudden large losses in wealth affect labor force participation?

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