Working Paper: CEPR ID: DP10849
Authors: Christian Bayer; Ralph Lütticke; Lien Phamdo; Volker Tjaden
Abstract: Households face large income uncertainty that varies substantially over the business cycle. We examine the macroeconomic consequences of these variations in a model with incomplete markets, liquid and illiquid assets, and a nominal rigidity. Heightened uncertainty depresses aggregate demand as households respond by hoarding liquid ``paper'' assets for precautionary motives, thereby reducing both illiquid physical investment and consumption demand. This translates into output losses, which a central bank can prevent by providing liquidity. We show that the welfare consequences of uncertainty shocks crucially depend on a household's asset position. Households with little human capital but high illiquid wealth lose the most from an uncertainty shock and gain the most from stabilization policy.
Keywords: Incomplete Markets; Nominal Rigidities; Uncertain Shocks
JEL Codes: E12; E22; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased household income uncertainty (D19) | depresses aggregate demand (E00) |
| increased household income uncertainty (D19) | increases precautionary savings (E21) |
| increased precautionary savings (E21) | reduces consumption demand (D12) |
| reduces consumption demand (D12) | lower output (E23) |
| increased household income uncertainty (D19) | increases holdings of liquid assets (F32) |
| a two standard deviation increase in income uncertainty (D89) | decreases aggregate activity by approximately 0.5% on impact (F62) |
| a two standard deviation increase in income uncertainty (D89) | decreases aggregate activity by approximately 0.4% over the first year (E20) |