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Time-varying idiosyncratic risk and aggregate consumption dynamics

Alisdair McKay ()

Journal of Monetary Economics, 2017, vol. 88, issue C, 1-14

Abstract: Long-term earnings losses for displaced workers are large and counter-cyclical. Similarly, the skewness of earnings growth rates is strongly pro-cyclical. This paper presents an incomplete markets business cycle model in which idiosyncratic risk varies over time in accordance with these empirical findings. These dynamics of idiosyncratic risk give rise to a cyclical precautionary savings motive that substantially raises the volatility of aggregate consumption growth. According to the model, idiosyncratic risk spiked during the Great Recession, leading to a substantial decline in aggregate consumption.

Keywords: Consumption; Idiosyncratic risk; Incomplete markets; Business cycle (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:moneco:v:88:y:2017:i:c:p:1-14