Working Paper: NBER ID: w26302
Authors: Jess Fernández-Villaverde; Samuel Hurtado; Galo Nuño
Abstract: This paper investigates how, in a heterogeneous agents model with financial frictions, idiosyncratic individual shocks interact with exogenous aggregate shocks to generate time-varying levels of leverage and endogenous aggregate risk. To do so, we show how such a model can be efficiently computed, despite its substantial nonlinearities, using tools from machine learning. We also illustrate how the model can be structurally estimated with a likelihood function, using tools from inference with diffusions. We document, first, the strong nonlinearities created by financial frictions. Second, we report the existence of multiple stochastic steady states with properties that differ from the deterministic steady state along important dimensions. Third, we illustrate how the generalized impulse response functions of the model are highly state-dependent. In particular, we find that the recovery after a negative aggregate shock is more sluggish when the economy is more leveraged. Fourth, we prove that wealth heterogeneity matters in this economy because of the asymmetric responses of household consumption decisions to aggregate shocks.
Keywords: Financial Frictions; Wealth Distribution; Heterogeneous Agents; Aggregate Shocks
JEL Codes: C45; C63; E32; E44; G01; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial frictions (G19) | multiple stochastic steady states (SSS) (C62) |
| negative aggregate shocks (E19) | severe recessions (F44) |
| high-leverage steady state (HLSS) (C62) | sluggish recovery (E65) |
| wealth heterogeneity (D31) | household consumption decisions (D10) |
| household consumption decisions (D10) | aggregate risk (E10) |
| high-leverage scenario (G41) | persistent expected path of interest rates (E43) |
| persistent expected path of interest rates (E43) | less severe declines in consumption among wealthy households (D12) |