Future Labor Income Research Articles

Capital market imperfections, taxation and household saving

This paper analyzes aggregate household saving under capital market imperfection, which is characterized by the wedge between the borrowing rate and the lending rate. Under these circumstances the assumption of a representative household is unlikely to hold and consumers are distributed into savers, liquidity-constrained consumers and borrowers depending on their characteristics such as the exogenous future labour income. An interest rate wedge is shown to affect saving positively. The permanent income tax effect is ambiguous a priori, but a temporary rise in the current income tax rate will decrease aggregate savings. In the second part of the paper an international data sample from 25 countries in the 1980s is used to evaluate the role of tax and interest rate wedge factors in addition to the usual life cycle variables a la Houthakker and Modigliani. On the whole, the results give some, though weak, support for this augmented Houthakker-Modigliani hypothesis. However, in sharp contrast with earlier findings the growth effect is negative.

Consumption and Liquidity Constraints: An Empirical Investigation

Several recent studies have suggested that empirical rejections of the permanent income/life cycle model might be due to the existence of liquidity constraints. This paper tests the permanent income hypothesis against the alternative hypothesis that consumers optimize subject to a well-specified sequence of borrowing constraints. Implications for consumption in the presence of borrowing constraints are derived and then tested using time-series/cross-section data on families from the Panel Study of Income Dynamics. The results generally support the hypothesis that an inability to borrow against future labor income affects the consumption of a significant portion of the population.

Consumption, Liquidity Constraints and Asset Accumulation in the Presence of Random Income Fluctuations

Recent empirical research, Flavin (1981), Hagashi (1982), has rejected the certainty-equivalent formulation of permanent income hypothesis, Hall (1978). These findings are often attributed to households' inability to borrow completely against expected future labor income. This paper is a theoretical investigation of optimal consumption behavior under risk aversion, random income fluctuations, and borrowing restrictions. Our principle objective is to establish the existence and to investigate the properties of the stationary probability distribution which characterizes the asymptotic behavior of consumption under these conditions. (This abstract was borrowed from another version of this item.)

Borrowing Constraints and Aggregate Economic Activity

A model of aggregate economic activity is formulated which enmphasizes the effects of borrowing constraints in the presence of uninsurable risk. An important determinant of current income level is shown to be the cross-sectional distribution of wealth. As this distribution evolves endogenously, the model is capable of producing rich dynamics from a simple specification of exogenous shocks. The model shows that this phenomena can contribute to observed price volatility. IT IS COMMONLY THOUGHT that individuals have only limited opportunities to borrow against future labor income and cannot totally insure all types of risk. It has also been suggested that such departures from the presumptive norm of frictionless, complete information capital markets may have implications for aggregate economic activity. AlthLough there has been some work analyzing the implications of borrowing constraints for individual savings behavior (18, 2, 8), there has been no systematic analysis of how such borrowing constraints will affect the time series properties of output, prices, and interest rates. In this paper, we present a completely specified infinitely lived two agent equilibrium model which emphasizes the roles of borrowing constraint and uninsured risk for affecting aggregate outcomes. Specifically we assume that agents are prohibited from ever having negative nonhuman wealth. The model has the central feature that there is no aggregate uncertainty, but each agent's own productive opportunities are stochastic. If there were a full set of Arrow- Debreu contingent claim markets each agent could attain a certain consumption stream and the resulting allocation and (implicit) relative prices would be constant through time. However, we assume that such markets do not exist. Rather, we assume that at each point in time agents may trade only the single durable asset for the single perishable consumption good. This may be interpreted either as fiat mon ay with a fixed own nominal return of zero, or as claims to productive capital which emits a fixed exogenous flow of the consumption good. We assume also that output may be produced by labor. However, only one of the two agents is productive at any instant in time. The duration of time over which a single agent is productive is assumed to be random, and, for analytical simplicity, is assumed to be generated by a Poisson counting process. The resulting allocation has the property that the agent who is not productive exchanges some of his

Optimal Consumption with a Stochastic Income Stream and Two Interest Rates

An individual's choice between consumption and investment is very complex and simplifications must be introduced in every model building. A common simplification is the elimination of uncertainty from the model by replacing random variables by their expected values, since in general the deterministic case is much simpler than its probabilistic counterpart. Examples of such random variables are future labor incomes and investment returns. Another type of simplification is the elimination of variables or opportunities from the model. For example, borrowing may be excluded from the individual's financial opportunities or it may be assumed that there exists only one interest rate, common to borrowers and lenders. A combination of the above attitudes has led to an important result obtained by Mirman [8] and Leland [4] in two period models, and Miller [6] and Mendelson and Amihud [5] in a multiperiod model. They have proved that in the case of one interest rate and additive utility functions, concavity and positive third derivative of the utility functions imply an increase in consumption when going from a random labor income case to its deterministic counterpart. In [5] and [7] this result is extended, and it is shown that consumption also increases when a random sequence of labor income is replaced by a less risky sequence. The importance of the above results is twofold; they supply qualitative knowledge on the impact of increased uncertainty in future labor income on the consumer's decisions, and they give an upper bound on the immediate consumption in probabilistic models. These results can be explained as follows: The assumptions imply convexity of the marginal utility functions which tend therefore to increase when randomness is introduced or increased. Therefore the expected marginal utility of future consumption (related to present savings) increases. This leads to an increased preference for future consumption at the expense of immediate consumption.

Education as an Option

To the student, education provides many benefits. In part, education produces human capital. By attending school and training on the job, the student acquires marketable skills, thereby sacrificing current labor income while augmenting future labor income. Among economists this concept is familiar. Beginning with the seminal work by Mincer (1958) and Becker (1964), models of the accumulation of human capital have been extended to the life cycle and, more recently, to uncertainty.' Simultaneously, several of these models have been tested empirically.2 To economists, education also serves as a signal. By completing a demanding educational program, the student signals to prospective employers that he possesses greater innate productivity than other potential employees not completing similar programs. This potentially greater productivity the employer then rewards with more favorable conditions of employment,