Tightening Financial Frictions on Households, Recessions, and Price Reallocations

Zhen Huo and José-Víctor Ríos-Rull

Review of Economic Dynamics, 2015, vol. 18, issue 1, 118-139

Abstract: We explore the effects of financial shocks in heterogeneous agent economies with aggregate savings and with frictions in some consumption markets, where demand contributes to productivity. Households of various wealth and earnings levels search for goods at different intensities and pay different prices in differently crowded markets. Increases in savings arising from a financial shock that tightens the borrowing limit trigger a recession via two channels: 1) the reduction in the consumption of goods that are subject to search frictions reduces productivity and output; 2) because the poorest households are more affected by the shock, consumption tilts toward the richest households, causing an additional reduction in output and productivity. We model fixed prices in a competitive search environment and show how price rigidities dramatically exacerbate the recession. (Copyright: Elsevier)

Keywords: Credit crunch; Endogenous productivity; Price dispersion; Household heterogeneity (search for similar items in EconPapers)
JEL-codes: E20 E32 E44 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (14)

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DOI: 10.1016/j.red.2014.10.004

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