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Time-varying idiosyncratic risk and aggregate consumption dynamics

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  • McKay, Alisdair

Abstract

Long-term earnings losses for displaced workers are large and counter-cyclical. Similarly, the skewness of earnings growth rates is strongly pro-cyclical. This paper presents an incomplete markets business cycle model in which idiosyncratic risk varies over time in accordance with these empirical findings. These dynamics of idiosyncratic risk give rise to a cyclical precautionary savings motive that substantially raises the volatility of aggregate consumption growth. According to the model, idiosyncratic risk spiked during the Great Recession, leading to a substantial decline in aggregate consumption.

Suggested Citation

  • McKay, Alisdair, 2017. "Time-varying idiosyncratic risk and aggregate consumption dynamics," Journal of Monetary Economics, Elsevier, vol. 88(C), pages 1-14.
    • Handle: RePEc:eee:moneco:v:88:y:2017:i:c:p:1-14
    DOI: 10.1016/j.jmoneco.2017.05.002
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