Optimal Saving and Work Hours in the Heterogeneous Agent Neoclassical Growth Model

58 Pages Posted: 18 Nov 2018 Last revised: 14 Jan 2019

See all articles by Akshay Shanker

Akshay Shanker

Australian National University (ANU) - Crawford School of Public Policy

Date Written: June 30, 2018

Abstract

This paper introduces work - leisure choice into a constrained optimal policy problem in a neoclassical growth model with idiosyncratic risk and incomplete markets. The constrained planner cannot complete markets, but must improve welfare subject to agents’ budget constraints. As such, rather than addressing the market failure of incomplete markets, the planner addresses the pecuniary externalities of each agents’ saving and work decision on interest and wage rates. In an economy calibrated to U.S. wealth and income inequality, the paper finds the constrained planner increases aggregate capital and reduces aggregate hours worked. The resulting increase in wages and fall in interest rates shifts the distribution of consumption towards the consumption poor, since they rely more on labor income than capital income. However, in a constrained efficient allocation, only highly productive individuals increase saving, while less productive individuals reduce saving. Moreover, only the asset poor and less productive agents reduce work hours; the wealthy and highly productive increase work hours due to wealth effects. While total work hours fall, the increase in work hours by the most productive is sufficient to increase effective labor supply.

Keywords: Constrained Efficiency, Incomplete Markets, Endogenous Labor Supply

Suggested Citation

Shanker, Akshay, Optimal Saving and Work Hours in the Heterogeneous Agent Neoclassical Growth Model (June 30, 2018). Available at SSRN: https://ssrn.com/abstract=3274102 or http://dx.doi.org/10.2139/ssrn.3274102

Akshay Shanker (Contact Author)

Australian National University (ANU) - Crawford School of Public Policy ( email )

ANU College of Asia and the Pacific
J.G. Crawford Building, #132, Lennox Crossing
Canberra, Australian Capital Territory 0200
Australia

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