January 17, 2019, 14:00–15:30
Job Market Seminar
This paper studies the interaction of household asset and labor market choices. In particular, I study the amplification due to this channel of the severity of the Great Recession as a result of the low risk environment prior to the downturn. A recent literature has established that the distribution of assets is crucial for the aggregate response of the economy to shocks. The income risk a household faces in the labor market is a key determinant of their asset allocation decision, but a household's asset position may also affect the jobs they choose. Therefore, causation can run in both directions. I build a model that incorporates a jobs ladder, heterogeneity in job risk and saving in liquid and illiquid assets. The model replicates the positive correlation between job risk and the liquidity of household portfolios and captures the housing choices following a job separation both measured in the PSID. The joint determination of asset and labor market outcomes provides a novel mechanism by which the state of the economy affects the magnitude of the aggregate response of consumption and housing choices to labor market shocks. The fact the Great Recession occurred following a decline in the job separation rate increased the negative response of consumption by 40 percent.