Precautionary Savings or Working Longer Hours?

This paper quantifies the size of precautionary savings implied by a dynamic general equilibrium model with heterogeneous agents when explicitly considering the labor supply decision of households. Key parameters as the intertemporal elasticities of substitution of consumption and leisure are obtained from observed household behavior by calibrating the model to reproduce in equilibrium relevant statistics from micro data. I find that precautionary savings are smaller than if they were measured by use of a model economy without labor decision and that they can even be negative. In addition, the incomplete markets economy is smaller in size than its complete markets counterparts. That is to say, aggregate output is smaller, between 82% and 94% of aggregate output in the complete markets economies. These result are in stark contrast to the ones implied by models without labor choice as Aiyagari (1994) and are due to the importance of hours as a mechanism to confront wage fluctuations.