Wage Risk, Employment Risk, and the Rise in Wage Inequality

Using a structural labor market model, we show that rising idiosyncratic wage risk and lower taxes at the bottom of the earnings distribution are the main forces behind rising wage inequality. The former contributes to the falling employment rate.

Falling real wages and rising disability risk further depressed employment of workers without a college degree and rising exogenous job destruction depressed employment of workers with a college degree. Higher idiosyncratic risk entails large welfare losses with the largest losses among workers without a college degree.