Policy Uncertainty and Precautionary Savings

This paper uses German micro data and a quasi-natural experiment to provide new evidence on the empirical importance of precautionary savings. Our quasi-natural experiment draws on a sharp increase in uncertainty (as reported in a survey of German citizens) observed in the run-up to the 1998 general election. Our estimates are obtained from a diff-in-diff estimator and thus overcome the identification problem that often aects measures of precautionary savings. We find that household saving increases significantly following the increase in uncertainty about the future path of income, suggesting a significant precautionary savings motive. We also analyze households'response in terms of labor market choices: we find evidence of a labor supply response by workers who can use the margin offered by part-time employment. While independent of the reasons why uncertainty increased in the run-up to the election, our results are suggestive of the economic effects of "wars of attrition", i.e. situations in which reforms are delayed because political parties are unable to agree on how the burden of a reform should be shared between various groups in society. Delays in adopting a reform, or the possibilty that a reform, after it has been adopted by one government might be revoked by another, raise uncertainty and induce households to save more: consumption may fall and the economy might slow down for no other reason than political uncertainty.