DP5322 Precautionary Savings or Working Longer Hours?

Author(s): Josep Pijoan-Mas
Publication Date: October 2005
Keyword(s): incomplete markets, labour supply, precautionary savings
JEL(s): C68, D31, E21, J22
Programme Areas: International Macroeconomics, Labour Economics, Public Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=5322

This paper quantifies the macroeconomic implications of the lack of insurance against idiosyncratic labour market risk. I show that in a model economy calibrated to observed individual level data, households make ample use of work effort as a consumption smoothing mechanism. As a consequence, aggregate consumption is 0.6% lower, work effort is 18% higher and labour productivity is 12% lower than they would be in a complete markets setting. Not surprisingly, the welfare benefits of moving towards complete markets are very large. Accounting for the whole transition to the new complete markets steady state I find the welfare costs of market incompleteness above 16% of individual lifetime consumption.