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Wealth and Volatility

Jonathan Heathcote () and Fabrizio Perri ()

Review of Economic Studies, 2018, vol. 85, issue 4, 2173-2213

Abstract: Between 2007 and 2013, U.S. households experienced a large and persistent decline in net worth. The objective of this article is to study the business cycle implications of such a decline. We first develop a tractable monetary model in which households face idiosyncratic unemployment risk that they can partially self-insure using savings. A low level of liquid household wealth opens the door to self-fulfilling fluctuations: if wealth-poor households expect high unemployment, they have a strong precautionary incentive to cut spending, which can make the expectation of high unemployment a reality. Monetary policy, because of the zero lower bound, cannot rule out such expectations-driven recessions. In contrast, when wealth is sufficiently high, an aggressive monetary policy can keep the economy at full employment. Finally, we document that during the U.S. Great Recession wealth-poor households increased saving more sharply than richer households, pointing towards the importance of the precautionary channel over this period.

Keywords: Business cycles; Aggregate demand; Precautionary saving; Multiple equilibria; Self-fulfilling crises; Zero lower bound (search for similar items in EconPapers)
JEL-codes: E12 E21 E52 (search for similar items in EconPapers)
Date: 2018
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Related works:
Working Paper: Wealth and Volatility (2015) Downloads
Working Paper: Wealth and Volatility (2015) Downloads
Working Paper: Wealth and Volatility (2015) Downloads
Working Paper: Wealth and Volatility (2013)
Working Paper: Wealth and Volatility (2012) Downloads
Working Paper: Wealth and Volatility (2011) Downloads
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