Nonlinear micro income processes with macro shocks

We propose a nonlinear framework that exploits both macro and micro data to study the dynamic transmission of aggregate and idiosyncratic shocks to household income. We develop identification arguments and estimation methods that combine macro time series and time series of panels. Using U.S. aggregate data and the PSID, we find that business-cycle fluctuations modulate the persistence of heterogeneous individual histories and the risk faced by households. We document how aggregate and idiosyncratic shocks propagate over time for households in different macro and micro states. Lastly, we quantify the welfare cost of aggregate and idiosyncratic risk.