Employment Time and the Cyclicality of Earnings Growth

We study how the distribution of earnings growth evolves over the business cycle in Italy. Wedistinguish between two sources of annual earnings growth: changes in employment time (number ofweeks of employment within a year) and changes in weekly earnings. Changes in employment timegenerate the tails of the earnings growth distribution, and account for the increased dispersion andnegative skewness in the distribution of earnings growth in recessions. In contrast, the cross-sectionaldistribution of weekly earnings growth is symmetric and stable over the cycle. Thus, models that relyon cyclical idiosyncratic risk, should separately account for the employment margin in their earningsprocess to avoid erroneous conclusions. We propose such a process, based on the combination ofsimple employment and wage processes with few parameters, and show that it captures the procyclicalskewness in changes in earnings growth and other important features of its distribution