We show that New Keynesian models with frictionless labor supply face a challenge: given standard parameters, they cannot simultaneously match plausible estimates of marginal propen- sities to consume (MPCs), marginal propensities to earn (MPEs), and fiscal multipliers. A HANK model with sticky wages provides a solution to this trilemma.
I document that spousal labor supply substantially mitigates the impact of cyclical labor income risk on married households. Motivated by this evidence, I present a macroeconomic model with incomplete markets in which households are heterogeneous by gender and marital status. Couples can smooth their consumption over the business cycle better than singles because (i) spouses rarely lose their jobs at the same time; and (ii) secondary earners can increase their labor supply on the extensive margin in response to a job loss of the primary earner. According to my estimated model, spousal insurance mitigates the volatility of aggregate consumption by about 40%. Spousal insurance acts as a powerful automatic stabilizer because it weakens the general-equilibrium feedback between unemployment risk and economic activity. My model clarifies the circumstances under which this automatic stabilizer is stronger or weaker. Spousal insurance is particularly powerful in recessions caused by traditional demand shocks. It is less powerful in recessions caused by shocks like the current COVID epidemic.
We propose a general and highly efficient method for solving and estimating general equilibrium heterogeneous-agent models with aggregate shocks in discrete time.