Unemployment benets, precautionary savings and demand Stefan Kühn International Labour Oce Project LINK Meeting 2016 Toronto, 19-21 October 2016
Outline 1 Introduction 2 Model 3 Results 4 Conclusion
Introduction Content of paper Treatment of unempoyment benets in DSGE models Unemployment benets are replacement income Neo-classical economics: Complete markets: unemployment is insured away Raise alternative value to work Raise wage demands Reduce employment, output and growth lower benets are positive supply shock
Introduction Content of paper Treatment of unempoyment benets in DSGE models Unemployment benets are replacement income Neo-classical economics: Complete markets: unemployment is insured away Raise alternative value to work Raise wage demands Reduce employment, output and growth lower benets are positive supply shock
Heterogeneous agent economics: Potentially only source of income Some optimal level of UB exists Relevant for policy: labour market reforms in crisis times
Literature review Representative agent general equilibrium model Limited impact on agent's utility UB to adjust to Hoisos condition (Moyen and Stähler, 2010) Microeconomic theory: Baily (1978) - Chetty (2006) formula Tradeo between consumption smoothing and job search incentive Heterogeneous agents in general equilibrium Labour demand eect important Pro-cyclical benets (Krusell et al., 2010; Mitman and Rabinovich, 2015) Inecient tightness: UB depends (Landais et al., 2015) Portfolio choice and volatility: larger optimal benets (Den Haan et al., 2015)
Literature review Representative agent general equilibrium model Limited impact on agent's utility UB to adjust to Hoisos condition (Moyen and Stähler, 2010) Microeconomic theory: Baily (1978) - Chetty (2006) formula Tradeo between consumption smoothing and job search incentive Heterogeneous agents in general equilibrium Labour demand eect important Pro-cyclical benets (Krusell et al., 2010; Mitman and Rabinovich, 2015) Inecient tightness: UB depends (Landais et al., 2015) Portfolio choice and volatility: larger optimal benets (Den Haan et al., 2015)
Literature review Representative agent general equilibrium model Limited impact on agent's utility UB to adjust to Hoisos condition (Moyen and Stähler, 2010) Microeconomic theory: Baily (1978) - Chetty (2006) formula Tradeo between consumption smoothing and job search incentive Heterogeneous agents in general equilibrium Labour demand eect important Pro-cyclical benets (Krusell et al., 2010; Mitman and Rabinovich, 2015) Inecient tightness: UB depends (Landais et al., 2015) Portfolio choice and volatility: larger optimal benets (Den Haan et al., 2015)
Solving heterogeneous household models Problem: very large number of state variables Approximative numerical solution (Krusell and Smith, 1998) This paper uses Challe et al. (2015) One large employed family sharing assets Agent loosing job takes assets and consumes these When out of assets only unemployment benets Upon job nding full member of employed family > Limited number of states
Solving heterogeneous household models Problem: very large number of state variables Approximative numerical solution (Krusell and Smith, 1998) This paper uses Challe et al. (2015) One large employed family sharing assets Agent loosing job takes assets and consumes these When out of assets only unemployment benets Upon job nding full member of employed family > Limited number of states
Contribution of the paper 1 Investigate unemployment benet reduction in standard New Keynesian model with heterogeneous households 2 Derive Nash wage bargaining equilibrium 3 With and without lower interest rate bound
Model features Standard New Keynesian model elements Cobb-Douglas production function with capital and labour Quadratic investment adjustment cost Calvo (1983) price stickiness Taylor rule, potentially lower bound Closed economy Search and matching labour market Fixed separation rate, vacancy posting cost, matching function No leisure, only extensive margin Unemployment benets as replacement wage Nash bargaining for wages by union weighing value functions by all workers Real wage rigidity Heterogeneous households following Challe et al. (2015)
Model features Standard New Keynesian model elements Cobb-Douglas production function with capital and labour Quadratic investment adjustment cost Calvo (1983) price stickiness Taylor rule, potentially lower bound Closed economy Search and matching labour market Fixed separation rate, vacancy posting cost, matching function No leisure, only extensive margin Unemployment benets as replacement wage Nash bargaining for wages by union weighing value functions by all workers Real wage rigidity Heterogeneous households following Challe et al. (2015)
Heterogeneous households Capital owners invest, hold asset counterposition for workers All employed workers in one family sharing assets Upon job loss worker takes his share in assets into unemployment Borrowing constraint: unemployed only have assets and benets Precautionary savings Consume assets quickly: could nd a job again MU(C eu ) = βr[νmu(c e ) + (1 ν)mu(c u )] Upon job nd immediately full member of employed family Only 3 states Employed Unemployed, consuming assets Unemployed without assets
Heterogeneous households Capital owners invest, hold asset counterposition for workers All employed workers in one family sharing assets Upon job loss worker takes his share in assets into unemployment Borrowing constraint: unemployed only have assets and benets Precautionary savings Consume assets quickly: could nd a job again MU(C eu ) = βr[νmu(c e ) + (1 ν)mu(c u )] Upon job nd immediately full member of employed family Only 3 states Employed Unemployed, consuming assets Unemployed without assets
Heterogeneous households Capital owners invest, hold asset counterposition for workers All employed workers in one family sharing assets Upon job loss worker takes his share in assets into unemployment Borrowing constraint: unemployed only have assets and benets Precautionary savings Consume assets quickly: could nd a job again MU(C eu ) = βr[νmu(c e ) + (1 ν)mu(c u )] Upon job nd immediately full member of employed family Only 3 states Employed Unemployed, consuming assets Unemployed without assets
Model key element Intertemporal saving decision by workers (λ marginal utility of consumption) λ e,t+1 = 1 1 ( ) (1) λ e,t β w r t λeu,t+1 1 + s t+1 λ e,t+1 1 Key mechanism Rise in probability to loose job (s) and fall in replacement wage (meaning lower C eu ) raise saving
Experiment Lower unemployment benets > wage falls Model with and without complete markets Lower interest bound (occbin toolkit by Guerrieri and Iacoviello, 2015) let interest rate fall by 0.4 pp
Deviation (in percentage points) Deviation (in percentage points) No lower bound 1.2 1 0.8 0.5 0.4 0 0 1 2 3 Years -0.5 1 2 3 Years Output Investment Employment Worker Consumpt. Output Investment Employment Worker_consumpt (a) Complete markets (b) Incomplete markets
Deviation (in percentage points) Deviation (in percentage points) Lower interest bound 1 0.4 0.5 0 0-0.4-0.5 1 2 3 Years Output Employment -0.8 1 2 3 Years Output Employment Investment Worker consumpt Investment Worker_consumpt (a) Complete markets (b) Incomplete markets
Conclusion Unemployment benets are important source of income Model should take this into account, abstracting from complete markets Eect of unemployment benet cut dramatically dierent
Future work Any type of labour market policy change aects precautionary saving Time-varying borrowing constraint Asset price variable Imperfect markets changes wage-employment adjustment balance in bargaining framework
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Key calibration Parameter Value Consumption loss of newly unemployed 20 % Borrowing limit 0 Intertemporal elasticity of subtitution 1 Habit persistence 0.7 Replacement wage 0.75 Probability going into unemployment 0.05 Price stickiness 0.8 Interest rate inertia 0.8