Macroeconomic and fiscal policy implications of household labor supply

This dissertation uses dynamic macroeconomic models with household heterogeneity to study the implications of household labor supply on household consumption dynamics and fiscal policy. Chapter 1 (joint work with Dirk Krueger) studies how the endogenous household labor supply channel affects the ability of households to smooth consumption against exogenous wage shocks. We show that a calibrated life-cycle two-earner household model with endogenous labor supply can rationalize the extent of consumption insurance against wage shocks estimated empirically by Blundell, Pistaferri, and Saporta-Eksten (2014) (BPS hereafter) in the U.S. data. With additive separable preferences, only 41% of male and 28% of female permanent wage shocks in the model pass through to household consumption. Most notably, the majority of the consumption insurance against permanent male wage shocks is provided through the endogenous labor supply response of the female earner. We also evaluate, using model-simulated data, the performance of the empirical approach of BPS on consumption responses to wage shocks and find only moderate biases. Chapter 2 studies the implications of changes in economic fundamentals such as increased female labor productivity, skill-biased technological change and aging population on the changes of the U.S. income tax code since the late 1970s. I first study these changes in economic fundamentals using an overlapping generations incomplete-markets life-cycle model with heterogeneous households. The model features both endogenous human capital accumulation and household labor supply and is calibrated to the U.S. economy in the 1970s and 2010s. Then I use this economic model to examine the income tax changes in a Ramsey optimal tax policy framework. I find that: (1) changes in economic fundamentals alone induce a less progressive optimal income tax and can account for 40% of the reduction in progressivity we observe; and (2) the change in Pareto weights required to explain the remaining part of tax policy change favors high-income households and also implies less valued government services. Finally, using a stylized political economy model, I discuss potential explanations for this change of Pareto weights such as the lower cost of conveying information to swing voters and the rising inequality of voter turnout among different socioeconomic groups