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Wealth and Volatility

Author

Listed:
  • Jonathan Heathcote
  • Fabrizio Perri
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.

Suggested Citation

  • Jonathan Heathcote & Fabrizio Perri, 2018. "Wealth and Volatility," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 85(4), pages 2173-2213.
    • Handle: RePEc:oup:restud:v:85:y:2018:i:4:p:2173-2213.
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    File URL: http://hdl.handle.net/10.1093/restud/rdx074
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    More about this item

    Keywords

    Business cycles; Aggregate demand; Precautionary saving; Multiple equilibria; Self-fulfilling crises; Zero lower bound;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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