LABOUR SUPPLY AND SAVING UNDER UNCERTAINTY*

This article examines how variations in labour supply can be used to self-insure against wage uncertainty and the impact of such self-insurance on precautionary saving. The analytical framework is a two-period model with saving and labour-supply decisions, where preferences are consistent with balanced growth. The main findings are that (i) labour-supply flexibility raises precautionary saving when future wages are uncertain, and (ii) uncertainty about future wages raises current labour supply and reduces future labour supply. Recent empirical and numerical studies indicate that labour supply is affected by uncertainty about future wages. For example Parker et al. (2005) find that self-employed American workers self-insure by working longer hours in response to greater uncertainty. Similarly, using a calibrated model, Low (2004) finds that young workers with much unresolved wage uncertainty work longer hours than old workers with little remaining wage uncertainty, and that labour-supply flexibility affects saving decisions over the life cycle. Low also demonstrates that allowing for labour-supply decisions and wage uncertainty is important for generating life-cycle consumption, savings and labour supply paths that are consistent with real-world data