Three Essays on the Macroeconomic Consequences of Labor Market Risk

Abstract

This dissertation consists of three self-contained essays that examine the macroeconomic consequences of labor market risk. The first two chapters focus on heterogeneity in labor market risk and its consequences on life-cycle earnings dynamics, wealth accumulation, and the design of optimal pension systems. Chapter 1 shows that heterogeneity in employment stability and the resulting earnings dynamics are a key driver of household saving behavior and wealth accumulation. In Chapter 2, I show that accounting for heterogeneity in employment stability makes the optimal pension system more progressive relative to the current U.S. system. Chapter 3 investigates how labor market shocks affecting the working-age population spill over to older households through the housing market. In Chapter 1, which is joint work with Moritz Kuhn and Gašper Ploj, we explore how heterogeneity in employment stability shapes earnings dynamics and savings behavior of workers. Such heterogeneity is a salient feature of labor markets where some workers hold stable, lifetime jobs, while others cycle frequently in and out of employment. Despite its prevalence, the economic consequences of this labor market feature remain underexplored. We fill this gap using both empirical analysis and quantitative modeling. We first document two new empirical facts: (1) workers with more stable employment experience faster earnings growth, and (2) they accumulate more wealth per dollar of income. Second, we develop a life-cycle model that combines a labor market search model with an incomplete markets model of saving behavior. We use the model to interpret the empirical facts, to establish a causal link from employment stability to wealth accumulation, and to quantify the drivers of the underlying mechanism. Our results support an important role of labor market heterogeneity to account for differences in wealth accumulation in financial markets. Chapter 2 explores the policy implications of heterogeneity in employment stability. Employment stability has important consequences for individual welfare as interrupted work histories and the consequent earnings losses lower pension entitlements and hinder the accumulation of life-cycle savings. This chapter studies how a progressive pension system can optimally account for such heterogeneity and quantifies the resulting welfare gains. Higher pension progressivity offers insurance against employment instability and helps to reduce lifetime earnings inequality, but comes at the cost of distorting human capital investment and retirement decisions. Using a life-cycle model with heterogeneous employment stability, endogenous human capital accumulation, and retirement decision, I find that abolishing the Social Security cap and increasing progressivity relative to the current U.S. pension system is optimal. The optimal pension system leads to a welfare gain equivalent to 0.75 % of lifetime consumption for new labor market entrants. Following the observed macroeconomic shift in the labor market towards higher employment stability since the 1990s, the optimal pension system becomes less progressive, yet still delivers substantial welfare improvements. Chapter 3 studies the consequences of labor market shocks on the housing market. Unemployment leads to large and persistent income losses for workers. Higher unemployment in the labor market therefore has spillover effects on the housing market. This paper studies such spillover effects from both empirical and theoretical perspectives. Using data from the Current Population Survey (CPS), I show that a 1 percentage point increase in the unemployment rate leads to a 1.55% decline in housing prices. Theoretically, I develop an overlapping generations model with a housing market. The calibrated model replicates the empirically observed spillover effect for the U.S. economy. Higher income uncertainty is the main driver of the spillover effect during periods of high unemployment, rather than the actual income losses. The spillover effect transmits one-third of the welfare losses of workers due to higher unemployment in the labor market to older, retired households by reducing their housing wealth. Younger workers benefit in part by buying houses at depressed prices. The magnitude of the spillover effect is shaped by the demographic structure of the population and the specific age groups affected by unemployment shocks. I find that increasing the generosity of unemployment insurance stabilizes the housing market, although it only partially mitigates the spillover effect.