Permanent inequality versus earnings instability and transmission of income shocks to consumption expenditure in India

Abstract

The economic inequality in India has increased in the past years, and this increase is related to the changes in the covariance structure. Using the CMIE data for the 18 waves, this paper deals with the dynamic structure of earnings in India for the period of six years (2014–2019) by decomposing the covariance structures of earnings into the permanent and transitory/temporary components. For this, we have used eight different models to examine the earnings dynamics. The results based on these eight different models are different depending upon the specification of the model used. Nevertheless, all the models have some common characteristics. They show that both permanent and transitory components are significant in determining income inequality. The permanent component dominates the temporary component for most of the considered period, which means that the labour market is rigid. The individuals’ starting point determines their lifetime earning profile. It also implies that low-paid individuals will see lower incomes throughout their life. This paper further examines the transmission of income shocks to consumption, based on the association at lags of unexplained income and consumption expenditure growth. The covariance gives information about the effect of income shocks on expenditure if the measurement errors in income and measurement errors in expenditure are uncorrelated (orthogonal). Results show the covariance increases initially, reaches its peak in December 2016, then decreases and becomes flat.