Editors' Summary

The Brookings Panel on Economic Activity held its ninetieth conference in Washington, D.C., on September 16 and 17, 2010, just as the economy was struggling to recover from the Great Recession. The Brookings Papers has always strived to provide timely policy analysis, and five of the papers in this volume study aspects of the causes and consequences of this slump. These papers examine the effects of the business cycle on the incomes of the very richest Americans; welfare, welfare reform, and poverty during recessions; the failure of modern macroeconomic models to adequately forecast economic conditions; the role of shadow banking in the financial crisis and the appropriate regulatory response; and expenditures by state and local governments over the business cycle. The remaining paper studies the impact of the No Child Left Behind Act, a far-reaching education reform that will shape the skills of the labor force for years to come.

In the first paper, Jonathan A. Parker and Annette Vissing-Jorgensen study the cyclicality of income at the very top of the income distribution. The conventional wisdom has been that the brunt of recessions falls on less educated, lower-income workers. Parker and Vissing-Jorgensen show, however, that households in the top 1 percent of the income distribution see their income rise steeply in booms and fall sharply in busts, much more so than the average household. This pattern is robust: it appears regardless of the occupation of the high-earning households and is not driven by the timing of exercising stock options. It is not even confined to the United States: the authors present evidence of similar patterns in Canada. Importantly, they find that consumption as well as income moves with the business cycle among those at the top.

These results do not mean that the conventional wisdom was entirely wrong, however. It remains true that less educated households also suffer disproportionately during recessions, largely because of increased unemployment. The impact of recessions on income is therefore U-shaped across the income distribution: many low-income households are adversely affected, the middle of the distribution is less affected, and the very top of the distribution is hit hard.

Parker and Vissing-Jorgensen's new results are driven in part by their examination of post-1982 data. In earlier years, when top incomes were not so extraordinarily high, they were also less cyclical. Thus, an increase in the cyclicality of high earners corresponded with an increase in their relative incomes. Parker and Vissing-Jorgensen show that this pattern holds across different income groups, across decades, and even across countries: the more unequal the income distribution, the more cyclical is the income of the rich. The authors conclude by developing a theoretical model linking income cyclicality with income inequality. The model suggests that one source of their findings may be progress in information and communications technology, which has enabled very high ability entrepreneurs to leverage their talents, earning them more in good times but exposing them to plummeting demand in bad times.

In the second paper, Marianne P. Bitler and Hilary W. Hoynes take the opposite perspective from Parker and Vissing-Jorgensen, exploring the cyclicality of well-being among the poorest. The United States has historically protected its poorest citizens from economic fluctuations through a patchwork system of welfare and social insurance programs: Aid to Families with Dependent Children provided cash assistance to poor families with children, while the food stamp program and Medicaid, among others, provided in-kind benefits. Welfare reform in the 1990s overhauled the cash assistance system (now called Temporary Assistance for Needy Families), and researchers have found that participation in this and some other welfare programs has declined since the reform. An unexplored—but currently pressing—question is whether welfare reform has weakened the social safety net, so that it no longer insures poor Americans against large income swings.

Bitler and Hoynes marshal an impressive array of evidence to attack this question, analyzing decades of data and studying numerous indicators of adult and child well-being. They find some evidence that welfare reform has weakened the safety net: poverty (using the official measure, which excludes noncash transfers) has risen more...