Trends in the Covariance Structure of Earnings in the U.S.: 1969-1987.

We examine the increasing variance of earnings of white men over the 1970s and 1980s by focusing on changes in the covariance structure of earnings. Using data from the Michigan PSID from 1969-1987, we find that about half of the increase has arisen from an increase in the variance of the permanent component of earnings and half from an increase in the variance of the transitory component, where the transitory component is composed of serially correlated shocks that die out within three years. We thus find that increases in the variability of earnings are of equal importance to increases in the dispersion of permanent earnings in explaining recent increases in earnings inequality.