ECB paper highlights role of mobility in earnings dynamics

Workers’ earnings uncertainty is driven less by persistent individual productivity shocks and more by job changes, according to a European Central Bank (ECB) working paper, offering new insights into how employment transitions shape income risks and economic policy.

The study, titled “Subjective earnings and employment dynamics”, develops a new method for measuring earnings, job and employment developments by using workers’ expectations about future income rather than relying only on realised earnings records.

The paper uses data from the Federal Reserve Bank of New York’s Survey of Consumer Expectations (SCE) to examine how uncertainty over future earnings affects labour market behaviour.

The researchers said existing approaches face significant challenges because observed earnings differences can reflect either genuine income risk or predictable differences between workers, such as ability, mobility or job quality.

They also highlighted the problem of selection bias, since earnings data are only available for people who are employed.

If workers experiencing negative shocks are also more likely to leave employment, the researchers argued that observed earnings histories may provide a distorted picture of the underlying risks faced by households.

The new approach instead uses workers’ expectations about possible future outcomes, including situations that do not eventually occur.

The SCE labour market module, collected monthly from March 2014 to November 2019, surveyed around 1,300 US household heads and asked both employed and unemployed respondents about potential job offers and their willingness to accept them.

Participants were asked about the annual salary of the best job offer they expected to receive over the following four months, the probability that offers would fall within different salary ranges and the likelihood they would accept offers at each income level.

According to the researchers, this creates variation similar to a controlled experiment because it captures both the wages available to workers and their decisions about whether to accept them before outcomes are realised.

The authors found that earnings shocks are smaller and disappear more quickly than previously estimated, while differences between workers and jobs play a much larger role in explaining income gaps.

The study concluded that stable differences in individual ability and the quality of employer-worker matches account for far more earnings variation than earlier research had suggested.

“Much of what looked like everyone facing large, long-lasting shocks is better described as different people being on persistently different earnings tracks,” the researchers said, adding that many changes in those tracks appear to be linked to job transitions.

The paper found that wage offers are a major driver of labour market movements, with higher offered salaries significantly increasing the likelihood that unemployed workers accept jobs and employed workers change employers.

By contrast, the wage level at a worker’s current job had a smaller effect on whether they remained with the same employer.

The findings have important implications for economic policy, particularly in areas such as unemployment insurance, taxation and monetary policy.

The researchers said understanding whether income differences arise mainly from uncertainty or from lasting differences between workers is crucial when designing policies aimed at supporting households.

They argued that quantitative economic models used for policy analysis need a more accurate breakdown between earnings risk and worker heterogeneity.

The study also suggested that labour market movements, including hiring, job-to-job transitions and separations, should receive closer attention when assessing household financial conditions and wage developments.

The authors said that earnings risk is concentrated around job transitions, meaning changes in employment status or employer are central to understanding income uncertainty over the economic cycle.

The paper also highlighted the growing importance of consumer expectations surveys, including the New York Fed’s SCE and the ECB’s own Consumer Expectations Survey.

The researchers said carefully designed questions about hypothetical situations allow economists to identify important features of the economy using more direct and transparent methods.

In their conclusions, the authors argued that expectations play a central role in economic decision-making because people’s perceptions of future outcomes influence their behaviour.

They said advances in measuring subjective expectations have allowed central banks and researchers to use survey data to gain new insights into labour market dynamics.

The study combined workers’ expectations with realised earnings data to estimate a structural model of earnings, employment and employer transitions.

The researchers said this approach allowed them to estimate factors such as individual ability, mobility and employer-worker match quality without relying on the strong assumptions often required when analysing realised earnings alone.

The findings differed significantly from previous research based only on income histories.

Earlier studies had suggested that productivity-related earnings shocks were highly persistent, with one influential estimate placing the persistence of such shocks at 0.96.

The ECB paper estimated a much lower persistence level of 0.51, suggesting that earnings shocks fade more quickly than previously believed.

The researchers also found that job-specific human capital is less likely to carry over after workers change employers than earlier estimates indicated.

A previous estimate suggested a carry-over rate of around 0.7, while the new research estimated it at 0.3.

At the same time, the study found much larger differences between individuals than earlier work had suggested.

For male workers, the researchers estimated the level of unobserved individual differences at 0.58, compared with 0.081 in previous research.

They argued that this difference was unlikely to be explained solely by missing information about workers, despite the relatively short period covered by the survey data.

The researchers used simulations to examine why previous studies may have reached different conclusions.

They found that when analysts look only at current earnings or earnings combined with individual characteristics, income risk and persistence appear high.

However, once job-specific differences are taken into account, both earnings risk and persistence decline substantially.

The main conclusion of the study is that, when workers remain with the same employer, earnings risk is relatively limited, while changes in employment are the main source of income uncertainty.