Business Cycles and Household Formation. The Micro versus the Macro Labor Elasticity (joint with Jose Victor Rios-Rull and Greg Kaplan).

Abstract:

We provide a new evidence on the cyclical behavior of the household size and labor market outcomes of young people conditional on their living arrangements in the United States from 1979 to 2010. Household size is countercyclial, which is mostly driven by young people moving into or delaying departure from the parental home. We document that young people living with the old work and earn less, and their hours and wages are more volatile relative to their peers living alone. We argue that living arrangements induce larger disparities in the labor market outcomes than age does. Motivated by these observations we provide a joint theory of household formation and labor market engagement including the business cycle. We lay down a theory where young individuals decide where to live depending on their relative wage rate, disutility of living with old and implicit transfers received from the old. We show differences in volatilities across age groups can be accounted for by incorporating household formation channel in to the real business cycle model, while restricting the labor elasticity of the old to be within the range measured by microeconomists. We use our model to infer the implied labor supply elasticities of the young and conclude young living together with the old have it 63.8% larger. Through the lens of the model we measure the size of the implicit transfers concluding they account for at least 163.2% percent of the market consumption of the young living with the old. The inclusion of people living in unstable households yields an implied aggregate, or macro, Frisch elasticity that is at least around 62.7% larger than the assumed micro elasticity.