Does Spousal Labor Smooth Fluctuations in Husbands` Earnings? The Role of Liquidity Constraints

Abstract

This paper theoretically and empirically investigates the role of spousal labor in buffering transitory shocks to husbands` earnings. To measure the amount of the shock that spousal labor absorbs, an instrumented cross-sectional variance decomposition is developed. Using data from the Panel Study of Income Dynamics, the paper finds that the smoothing resulting from the wives` labor response (both labor force participation and hours of work) is larger for households with limited access to credit. This finding, which is consistent with the model`s prediction, indicates that because of the presence of liquidity constraints, the temporal change in family income (exclusive of wives` earnings) reinforces the substitution effect in explaining the effect of shocks to the husbands` earnings on spousal labor.

Keywords: female labor supply, spousal labor participation, consumption smoothing, liquidity constraints

JEL Classification: D1, D91, J21, J22