DP16952 Idiosyncratic Income Risk and Aggregate Fluctuations

Author(s): Davide Debortoli, Jordi Galí
Publication Date: January 2022
Keyword(s): Economic Fluctuations, HANK models, Heterogeneous Agents, Idiosyncratic Shocks, monetary policy
JEL(s): E21, E32, E50
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16952

We study the role of idiosyncratic income shocks for aggregate fluctuations within a simple heterogeneous household framework with no binding borrowing constraints. We show that the presence of idiosyncratic income shocks affects the economy's response to an aggregate shock in a way that can be captured by a consumption-weighted average of the changes in uncertainty generated by the shock. We apply this framework to two example economies ---an endowment economy and a New Keynesian economy--- and show that under plausible calibrations the impact of idiosyncratic income shocks on aggregate fluctuations is quantitatively small, since most of the changes in uncertainty are concentrated among poorer (low consumption) households.