1. London School of Economics 2011 Labour Markets and Savings Christopher A Pissarides London School of Economics European Colloquia An Era of Macro & Micro Frictions Iseo, Italy 14 & 15 September 2011 1

2. London School of Economics 2011 2 Outline Employment histories and the role of frictions The three phases of lifecycle saving Some comments on cross-country comparisons and the recession The end of the baby boom era and employment trends

3. London School of Economics 2011 3 Employment histories

4. London School of Economics 2011 4 Employment histories Typically, employment for young workers is a fragile state Young workers go job shopping, take jobs to try them out, leave for extended periods and generally they are in transition Unemployment is often regarded as one of the transitional states they go through

5. London School of Economics 2011 5 Settling down For professional workers, the shopping might be related to internships, probation periods, professional training and the like There is again change of employers, but with less unemployment Generally, young workers settle down to a job a few years after labour force entry, say by their late 20s or early 30s

6. London School of Economics 2011 6 Job tenures Job tenures after the initial settling down are typically long There is a lot of job turnover in the statistics, but most of it is for jobs with short tenures Long tenures continue until retirement Unemployment for older groups is a much worse experience than for younger workers, for its non-financial consequences and in terms of later income prospects

7. London School of Economics 2011 Micro frictions The theory of search (markets with frictions) explains how the process of job reallocation takes place What is the influence of education, unemployment income (including unemployment compensation), active labour market policy and the macro environment on the probability of leaving unemployment and staying in employment? From this one can get the equilibrium employment and unemployment rate for different age groups 7

8. London School of Economics 2011 Macro frictions and cycles Unemployment rates for young workers are typically much higher than for older groups They rise faster in recession and fall faster – more volatility, more income uncertainty Because of the impact that unemployment has on skills and ability to integrate into the labour market, governments spend a lot of resources to help reduce the duration of unemployment of young workers 8

9. London School of Economics 2011 Lifecycle savings 9

10. London School of Economics 2011 10 Savings How are employment histories related to savings? Modern savings theory derived as a residual to consumption theory Typically, households want to stabilise consumption patterns on the basis of expected lifetime incomes Consumption does respond to changes in current income but fluctuates less. Response due to e.g., uncertainty or liquidity

11. London School of Economics 2011 Very young workers Young people typically do no saving – and if they do it is in small liquid accounts They rely on parents or the state for consumption funding if there is job loss Main problem for them is liquidity shortage 11

12. London School of Economics 2011 Three phases of savings There are three savings phases in a typical lifetime, related to the labour market experience and consumption patterns of the household members –Saving for a house –Saving for retirement –Saving for post-retirement consumption 12

13. London School of Economics 2011 Savings phase I Young adults – late 20s early 40s –Saving is for the acquisition of a major non-financial asset, typically a house –There could be some precautionary saving, for job loss or other unexpected events –But in countries with a welfare state that subsidises unemployment and health, the precautionary form of saving practically disappeared 13

14. London School of Economics 2011 Savings phase II Older adults – mid 40s to mid 60s –Starting in the mid 40s, predominant type of saving is for retirement –Most saving for retirement is done through company plans or the government –There is good understanding by households of the implications of corporate or government saving for their retirement and their private saving 14

15. London School of Economics 2011 Savings phase III Retired individuals – mid 60s and beyond –Life expectancy increased, people expect retirement of 20 years or so –Enter retirement with large reserves of cash –Saving for income is important way of financing retirement consumption 15

16. London School of Economics 2011 Comments on cross-country comparisons and the recession 16

17. London School of Economics 2011 17 Comment on cross-country comparisons To understand differences in savings rates across countries we have to take into account corporate saving and government saving A near impossible task! For example, most saving for professional classes in the US is done by corporations. In European countries like Greece by the public sector. In the UK by both

18. London School of Economics 2011 18 Comments on savings dynamics Why have aggregate saving rates been declining in the last 2-3 decades, at least up to the recession? I suspect main reason is stock market appreciation – if taken into account decline disappears But also bigger commitment of corporations and government to pension provision reduces private saving

19. London School of Economics 2011 19 Recession dynamics Sharp increase in saving rates in recession One cause is the previous process in reverse – fall in stock prices But the current recession is unusual. Caused by financial failures. There is a large increase in the demand for liquidity – see how the various QEs have been absorbed with very little impact on real economy: A liquidity trap!

20. London School of Economics 2011 20 Liquidity The demand for liquidity is essentially a precautionary demand for money It is a portfolio adjustment but shows up as an increase in household savings because of inadequate measurement As housing wealth and stock prices fell, households increased saving into liquid financial assets to restore wealth and restructure portfolios into more liquid form

21. London School of Economics 2011 The end of the baby boom era and employment trends 21

22. London School of Economics 2011 22 Generations X, Y, Z The baby boom generation enjoyed most prosperity ever known: started earning income in late 1960s, enjoyed boom of 1990s High income growth and their big numbers imply aggregate savings available for retirement are at a level unlikely to be repeated They are now entering the retirement stage where most need is how to take best advantage of accumulated savings

23. London School of Economics 2011 23 Beyond the baby boomers Next generations less numerous but also enjoyed prosperity and likely to receive large inheritances Great recession hit them more than baby boomers They have accumulated savings but rate of growth of aggregate saving falling because of population ageing

24. London School of Economics 2011 24 Another labour market trend Feature of labour markets virtually everywhere in developed world is increased income inequality Lower incomes stagnating (in Europe) or even falling (in US) Labour economists debate reasons but reasons irrelevant for savings Increased inequality should be good for aggregate savings because wealthy save more

25. London School of Economics 2011 25 Concluding remarks: what type of savings instrument? The implications of the analysis for the type of savings instrument are clear: the best type depends on labour market state of the household and the aggregate economy Young employed adults: capital growth in medium term and more liquid instruments that yield income to spend on a new house – although a mortgage is likely to absorb all reserves

26. London School of Economics 2011 26 Saving instruments, cont. Older adults: instruments that give capital growth, pensions Retired individuals: liquid, high income with some decumulation; inheritance planning With baby boom generation entering this phase this is likely to be the most popular type