Working Paper: CEPR ID: DP17080
Authors: Tommaso Monacelli; Roberto Colarieti
Abstract: We lay out a heteroskedastic New Keynesian model, consistent with the evidence of pervasive cross-sectional variation in individual income risk in micro data. We obtain three main results. First, heterogeneous marginal propensities to consume (MPCs) result from the sensitivity of precautionary savings to realized earnings being heterogeneous across agents. Second, the response of aggregate output to demand shocks hinges crucially on how individual risk co-varies with the degree of individual income cyclicality across the income distribution. Third, the general equilibrium effects of monetary and fiscal policy can be suitably summarized by a set of observable cross-sectional sufficient statistics. Depending on the sign of those statistics, income heteroskedasticity may: (i) dampen or amplify the response of output to demand shocks; (ii) affect the local determinacy of the equilibrium; (iii) attenuate or exacerbate the forward guidance puzzle. We conjecture an incomplete information framework with Bayesian learning as a plausible microfoundation for individual income heteroskedasticity.
Keywords: heteroskedasticity; precautionary savings; aggregate demand; monetary policy
JEL Codes: E52; E32; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Heterogeneous marginal propensities to consume (MPCs) (E21) | Consumption patterns (D10) |
| Income volatility changes (D31) | Consumption patterns (D10) |
| Negative realization of income (H24) | Individual risk (D81) |
| Individual risk (D81) | Consumption behavior (D10) |
| General equilibrium effects of monetary and fiscal policy (E63) | Response of output to demand shocks (E39) |
| Signs of sufficient statistics (C20) | Response of output to demand shocks (E39) |
| Negative signs for sufficient statistics (C46) | Insufficient Taylor principle for local determinacy (C62) |
| Positive signs for sufficient statistics (C12) | Sufficient Taylor principle for local determinacy (C62) |