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

Author

Listed:
  • Edouard Challe

    (Department of Economics, Ecole Polytechnique - X - École polytechnique - CNRS - Centre National de la Recherche Scientifique)

  • Xavier Ragot

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

Abstract

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.

Suggested Citation

  • Edouard Challe & Xavier Ragot, 2010. "Aggregate Consumption in Times of Crisis: The Role of Financial Frictions," Post-Print halshs-00944933, HAL.
  • Handle: RePEc:hal:journl:halshs-00944933
    DOI: 10.1093/cesifo/ifq006
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00944933
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    References listed on IDEAS

    as
    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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    Cited by:

    1. repec:ids:intjaf:v:7:y:2017:i:1:p:31-48 is not listed on IDEAS
    2. Anna Florio, 2013. "The Implied Consumer Euler Rate: What Role for Financial Frictions?," CESifo Economic Studies, CESifo, vol. 59(4), pages 650-675, December.

    More about this item

    Keywords

    Incomplete markets; unemployment; consumption;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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