A general decomposition formula with interaction effects

Abstract

This note presents a general way to decompose differences over time or between objects into the ceteris paribus effects and the interaction effects of an arbitrary number of factors. The decomposition addresses the issue of interaction effects between factors which have been neglected in the decomposition literature. It has the additional advantage of being path-independent and aggregation consistent. An empirical application studying distributional change demonstrates that interaction effects may be a relevant feature of reality that is overlooked if other decomposition methods are used.