Shocks, Frictions, and Inequality in US Business Cycles
Christian Bayer and
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Christian Bayer: Universitaet Bonn
Ralph Luetticke: University College London
No 256, 2019 Meeting Papers from Society for Economic Dynamics
The liquidity of the US housing market undergoes large swings that lead the business cycle. After an increase in the time to sell a house, output falls while households increase their liquid asset holdings and simultaneously lower residential investment. A model of incomplete markets and nominal rigidities can rationalize the observed behavior. When houses become less liquid assets, households maintain the capacity for consumption smoothing by demanding a larger portfolio share of liquid (paper) assets instead of houses. This leads to a demand-driven recession. The recessionary effects get stronger if the banking sector produces liquid assets from mortgaging houses.
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