Working Paper: NBER ID: w20994
Authors: Jonathan Heathcote; Fabrizio Perri
Abstract: Periods of low household wealth in United States macroeconomic history have also been periods of high business cycle volatility. This paper develops a simple model that can exhibit self-fulfilling fluctuations in the expected path for unemployment. The novel feature is that the scope for sunspot-driven volatility depends on the level of household wealth. When wealth is high, consumer demand is largely insensitive to unemployment expectations and the economy is robust to confidence crises. When wealth is low, a stronger precautionary motive makes demand more sensitive to unemployment expectations, and the economy becomes vulnerable to confidence-driven fluctuations. In this case, there is a potential role for public policies to stabilize demand. Microeconomic evidence is consistent with the key model mechanism: during the Great Recession, households with relatively low wealth, ceteris paribus, cut expenditures more sharply.
Keywords: No keywords provided
JEL Codes: E12; E21; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Household wealth (G59) | Sensitivity of consumer demand to unemployment expectations (D12) |
| Sensitivity of consumer demand to unemployment expectations (D12) | Macroeconomic volatility (E39) |
| Household wealth (G59) | Macroeconomic volatility (E39) |
| Low household wealth (G51) | Increased precautionary savings (E21) |
| Increased precautionary savings (E21) | Diminished consumption (E21) |
| Low household wealth (G51) | High macroeconomic volatility (E32) |
| Economic downturns (E32) | Increased savings rates of low net worth households (D14) |
| Public policies (H59) | Stabilizing demand during low household wealth (D12) |