a look at

The Residual Method

redistributionrecession.com

Overview
Many factors potentially reduced
labor hours after 2007.
Some factors are better understood,
or more easily quantified, than others.
Step 1: Quantify the impact of the
better-known factors.

Overview
Step 2: Subtract that impact from the
actual labor hours change to get a
residual change
Residual is a model of what would have
happened to labor hours but for the
influence of the better-known factors.
Residual is a model of the combined
impact of all other factors.

If the residual change is found to be

insignificant, that is a result and not
an assumption.

Generic Version
Interested in outcome y.
Some factors x affecting y are better
understood, or more easily quantified,
than others .
y = f(x,)
x is well measured and fx is known
dy = fxdx + fd
e.g., growth accounting explains output
growth with growth in labor and capital,
plus a Solow residual
e.g., gender wage gap is explained by
gender hours and education gaps, plus a
discrimination residual

Baby Boom vs. Other

Factors
The age of the
population affects the
amount of labor, because age is
associated with willingness to work.

Step 1: Examine the effect of aging.

How is the age distribution different at
each date t than it was before the
recession began?
How is aging related to hours worked?
e.g., examine 2007 cross-section hoursage profile (including zeros for people
not working).
Product is (estimate of) the impact of
aging on date t hours worked.

Baby Boom vs. Other

Factors
Step 2: Subtract
that impact from

actual or unadjusted hours series to

get residual or age-adjusted series.
Because the aging impact is negative, the
residual hours series exceeds the actual
hours series.

Reach conclusions about non-age

factors without knowing much about
them.

 Conclusions:
The omitted/non-age factors have partly,
but not fully, returned to their prerecession values.
The omitted factors are most of what
happened.
The residual method does not assume
that omitted factors are negligible.

Multiple Known Factors

Step 1: Calculate the impact of each
known factor separately. Include
interaction term impacts, if known.
Step 2: Subtract each impact term
from the actual hours series.
The residual shows (an estimate of)
the impact of all of the remaining
unknown factors (a.k.a., omitted
factors).
The size of the residual does not
depend on assumptions about the
omitted factors, but rather on the size
of the impact of the known factors

Redistribution vs. Other Factors

Payments to the poor and
unemployed affect the amount of
labor, because those payments reduce
reward to working by reducing what
are person loses by working less.
Step 1: Examine the effect of safety
net expansions.
What did the expansions add to the
average marginal tax rate?
How much does each tax rate point affect
the quantity of labor (prior literature on
wage elasticities of labor supply and
labor demand).
Product is (estimate of) the impact of
safety net expansions on date t hours
worked.

Redistribution vs. Other Factors

Step 2: Subtract that impact from
actual hours series to get residual or
MTR-constant series.
Because the safety net impact is negative,
the residual hours series exceeds the
actual hours series.

Reach conclusions about non-safetynet factors without knowing much

about them.

 Conclusions:
The omitted factors noticeably depressed
the labor market, but

Redistribution/safety net expansions

mattered more