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Aggregate Consumption in Times of Crisis: The Role of Financial Frictions

Listed author(s):
  • Edouard Challe

    (Ecole Polytechnique [Palaiseau])

  • Xavier Ragot

    (PSE - Paris-Jourdan Sciences Economiques - CNRS - Centre National de la Recherche Scientifique - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENS Paris - École normale supérieure - Paris - École des Ponts ParisTech (ENPC), Banque de France - Banque de France, PSE - Paris School of Economics)

The joint behaviour of US aggregate consumption and saving over the period 2007-2009, and notably the pronouned U-shaped pattern of consumption together with the rise in saving, are difficult to reconcile with the view that financial markets are frictionless. We propose an alternative framework in which financial markets are incomplete and where households form a buffer stock of precautionary saving to self-insure against the (time-varying) risk of falling into unemployment, with the consequence of considerably amplifying and propagating crises. Our model can be solved in closed form because the wealth heterogeneity generated by uninsured income shocks remains minimal. We end the article by arguing that fully incorporating uninsured and time-varying individual risks into macroeconomic analysis may drastically alter our understanding of the business cycle, macroeconomic policy, and the role of financial intermediaries.

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Paper provided by HAL in its series Post-Print with number halshs-00754434.

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Date of creation: Jul 2010
Publication status: Published in CESifo Economic Studies, Oxford University Press (OUP), 2010, 56 (4), pp.627-648. <10.1093/cesifo/ifq006>
Handle: RePEc:hal:journl:halshs-00754434
DOI: 10.1093/cesifo/ifq006
Note: View the original document on HAL open archive server: https://hal-pjse.archives-ouvertes.fr/halshs-00754434
Contact details of provider: Web page: https://hal.archives-ouvertes.fr/

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  1. Bewley, Truman, 1983. "A Difficulty with the Optimum Quantity of Money," Econometrica, Econometric Society, vol. 51(5), pages 1485-1504, September.
  2. Imrohoroglu, Ayse, 1992. "The welfare cost of inflation under imperfect insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 16(1), pages 79-91, January.
  3. Challe, Edouard & Le Grand, François & Ragot, Xavier, 2013. "Incomplete markets, liquidation risk, and the term structure of interest rates," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2483-2519.
  4. Edouard Challe & Xavier Ragot, 2011. "Fiscal Policy in a Tractable Liquidity‐Constrained Economy," Economic Journal, Royal Economic Society, vol. 121(551), pages 273-317, March.
  5. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
  6. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-976, October.
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