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Title: Precautionary Savings, Illiquid Assets, and the Aggregate Consequences of Shocks to Household Income Risk

Author(s): Christian Bayer, Ralph Lütticke, Lien Pham-Dao and Volker Tjaden

Publication Date: September 2015

Keyword(s): incomplete markets, nominal rigidities and uncertain shocks

Programme Area(s): Monetary Economics and Fluctuations

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.

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Bibliographic Reference

Bayer, C, Lütticke, R, Pham-Dao, L and Tjaden, V. 2015. 'Precautionary Savings, Illiquid Assets, and the Aggregate Consequences of Shocks to Household Income Risk'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10849