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Aggregate Consumption in Times of Crisis: The Role of Financial Frictions

Edouard Challe () and Xavier Ragot ()

Sciences Po publications from Sciences Po

Abstract: The joint behaviour of US aggregate consumption and saving over the period 2007–2009, and notably the pronouned U-shaped pattern of consumption together with the rise in saving, are difficult to reconcile with the view that financial markets are frictionless. We propose an alternative framework in which financial markets are incomplete and where households form a buffer stock of precautionary saving to self-insure against the (time-varying) risk of falling into unemployment, with the consequence of considerably amplifying and propagating crises. Our model can be solved in closed form because the wealth heterogeneity generated by uninsured income shocks remains minimal. We end the article by arguing that fully incorporating uninsured and time-varying individual risks into macroeconomic analysis may drastically alter our understanding of the business cycle, macroeconomic policy, and the role of financial intermediaries.

Keywords: Incomplete markets; Unemployment; Consumption (search for similar items in EconPapers)
JEL-codes: E21 (search for similar items in EconPapers)
Date: 2010-12
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Published in CESifo Economic Studies, 2010, vol. 56, pp.627-648

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Related works:
Working Paper: Aggregate Consumption in Times of Crisis: The Role of Financial Frictions (2010)
Working Paper: Aggregate Consumption in Times of Crisis: The Role of Financial Frictions (2010)
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