Estimating The Impact Of Transitory Income Fluctuations On Home Maintenance Expenditures: A Heterogeneous Growth Model Approach

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Estimating the Impact of Transitory Income Fluctuations on Home MaintenanceExpenditures: A Heterogeneous Growth Model ApproachThere are two approaches to isolating transitory income fluctuations. The first approach is to findinstruments fortransitory income changes. Examples might include an indicator for temporarylayoffs and changes in hours worked. This approach is difficult to implement with the post-1985AHSdata since it does not include most of the candidate instruments that have been used in theliterature.The second approach is to assume a specific model for the earnings process and thenuse the structure of that model to construct the transitory income component. We follow thisstrategy.Consider the following specification for household earnings,(1) ln(Yit)=Xitβ+μit+εit, whereYitis theithhousehold’s earnings in yeart,Xitis a set ofdemographic and human capital variables capturing life-cycle earnings profiles, μitis thepermanent component of residual earnings, and εitis the transitory component of residualearnings. The permanent component is typically modeled either as a random walk or aheterogeneous growth process.5Baker (1997) tests the random walk specification against theheterogeneous growth specification as given in equation (2) usingPanel Study of IncomeDynamicsdata and a common set of controls for the life-cycle earnings profiles,the sample usedin the estimation (by about 30%) and increases the average length of the panel for each household. Thosedetails are available upon request. For example, using thePanel Study of Income Dynamics, they reportthat temporary layoffs are not a significant predictor for household income changes. Thus, at least someof the candidate instruments are not very powerful.On the random walk specification, see MaCurdy (1982), Abowd and Card (1989), Topel (1991), Topeland Ward (1992), and Moffitt and Gottschalk (1995).(2)μit=γi+λiExpit, whereExpitis the potential labor market experience for theithhousehold.He finds the data to be more supportive of the heterogeneous growth specification.We use the heterogeneous growth specification to estimate the transitory residual earningscomponent in two steps. In the first step, equation (1) is estimated by regressing log earnings onset of demographic and human capital variables.6In the second step, equation (2) is estimated foreach household by regressing its earning residuals( )it itμ+εon the household head’spotential labor market experience, which is measured as the age of the head minus imputed yearsof schooling minus six. The residuals from thesesecond-stage regressions serve as our estimatesof the transitory residual earnings component, εit.7Using these estimates, we can decomposefamily log earnings into its permanent component ( lnPˆ ˆ ˆit it i i itY≡Xβ+γ+λExp) andits transitory component ( lnTˆit it itY≡ε+m), where ˆitmrepresents the combined effects ofmeasurement and estimation error.Following Dynarski and Gruber (1997), we restrict our sample to households with heads betweenthe ages of twenty and fifty-nine. In contrast to those authors, we include female-headedhouseholds as well as male-headed households. We drop observations if any of the incomevariables are allocated, and further restrict the sample to houses located in 114 SMSAs for whichwe can merge in Freddie Mac repeat-sale house price data. Metro area house price data isemployed to control for possible home “equity” effects on the household’s maintenance decision.

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