Labor Market Shocks and the Dynamics of the Aggregate Saving Rate in General Equilibrium

This paper studies the effects of shocks to the flow hazards into and out of unemployment on the aggregate household saving rate, and attempts to explain the spike in the US saving rate during the Great Recession with these shocks. The results are obtained from a Dynamic Stochastic General Equilibrium model under incomplete markets and borrowing constraints similar to Krusell and Smith (1998) using extended path algorithm, perturbation method and approximate aggregation. It is found that a negative job-finding shock and a positive job-separation shock simultaneously and separately contribute to an increase in the saving rate. Shocks to the job-finding probability create a more drastic and persistent impact on the saving rate than do shocks to the job-separation probability. The baseline model generates the saving rate that exhibits strikingly similar dynamics to the US saving rate; however, the magnitude of the model-generated responses is somewhat smaller than what can be observed in the US. Job-finding shocks alone explain almost all the dynamics of the saving rate during the Great Recession whilst both job-finding and job-separation shocks are important in explaining the saving dynamics during normal times. The same analysis under the complete market assumption yields results completely opposite to the US data.