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Wealth and Volatility

Jonathan Heathcote () and Fabrizio Perri ()

No 508, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: Periods of low household wealth in United States macroeconomic history have also been periods of high business cycle volatility. This paper develops a simple model that can exhibit self-fulfilling fluctuations in the expected path for unemployment. The novel feature is that the scope for sunspot-driven volatility depends on the level of household wealth. When wealth is high, consumer demand is largely insensitive to unemployment expectations and the economy is robust to confidence crises. When wealth is low, a stronger precautionary motive makes demand more sensitive to unemployment expectations, and the economy becomes vulnerable to confidence-driven fluctuations. In this case, there is a potential role for public policies to stabilize demand. Microeconomic evidence is consistent with the key model mechanism: during the Great Recession, consumers with relatively low wealth, ceteris paribus, cut expenditures more sharply.

Keywords: Aggregate demand; Business cycles; Multiple equilibria; Precautionary saving (search for similar items in EconPapers)
JEL-codes: E21 E12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mfd
Date: 2015-02-23
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Related works:
Journal Article: Wealth and Volatility (2018) 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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