IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/21448.html
   My bibliography  Save this paper

Incomplete Markets and Aggregate Demand

Author

Listed:
  • Iván Werning

Abstract

I study aggregate consumption dynamics under incomplete markets, focusing on the relationship between consumption and the path for interest rates. I first provide a general aggregation result under extreme illiquidity (no borrowing and no outside assets), deriving a generalized Euler relation involving the real interest rate, current and future aggregate consumption. This provides a tractable way of incorporating incomplete markets in macroeconomic models, dealing only with aggregates. Although this relation does not necessarily coincide with the standard representative-agent Euler equation, I show that it does for an important benchmark specification. When this is the case, idiosyncratic uncertainty and incomplete markets leave their imprint by affecting the discount factor in this representation, but the sensitivity of consumption to current and future interest rates is unaffected. An immediate corollary is that “forward guidance” (lower future interest rates) is as powerful as in representative agent models. I show that the same representation holds with positive liquidity (borrowing and outside assets) when utility is logarithmic. I show that away from these benchmark cases, consumption is likely to become more sensitive to interest rate, and especially future interest rates. Finally, I apply my approach to a real business cycle economy, providing an exact analytical aggregation result that complements existing numerical results.

Suggested Citation

  • Iván Werning, 2015. "Incomplete Markets and Aggregate Demand," NBER Working Papers 21448, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:21448
    Note: EFG IFM ME
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w21448.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Veronica Guerrieri & Guido Lorenzoni, 2017. "Credit Crises, Precautionary Savings, and the Liquidity Trap," The Quarterly Journal of Economics, Oxford University Press, vol. 132(3), pages 1427-1467.
    2. Vincent Sterk & Silvana Tenreyro, 2013. "The Transmission of Monetary Policy Operations through Redistributions and Durable Purchases," CEP Discussion Papers dp1249, Centre for Economic Performance, LSE.
    3. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
    4. Adrien Auclert, 2015. "Monetary Policy and the Redistribution Channel," 2015 Meeting Papers 381, Society for Economic Dynamics.
    5. Kaplan, Greg & Violante, Giovanni L, 2011. "A Model of the Consumption Response to Fiscal Stimulus Payments," CEPR Discussion Papers 8562, C.E.P.R. Discussion Papers.
    6. Ravn, Morten O. & Sterk, Vincent, 2017. "Job uncertainty and deep recessions," Journal of Monetary Economics, Elsevier, vol. 90(C), pages 125-141.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Cúrdia, Vasco & Woodford, Michael, 2016. "Credit Frictions and Optimal Monetary Policy," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 30-65.
    2. Michelacci, Claudio & Paciello, Luigi, 2017. "Ambiguous Policy Announcements," CEPR Discussion Papers 11754, C.E.P.R. Discussion Papers.
    3. Ricardo Reis & Alisdair McKay, 2015. "Optimal Automatic Stabilizers," 2015 Meeting Papers 608, Society for Economic Dynamics.
    4. Jordi Galí, 2018. "The State of New Keynesian Economics: A Partial Assessment," NBER Working Papers 24845, National Bureau of Economic Research, Inc.
    5. Adrien Auclert, 2015. "Monetary Policy and the Redistribution Channel," 2015 Meeting Papers 381, Society for Economic Dynamics.
    6. Ravn, Morten O & Sterk, Vincent, 2016. "Macroeconomic Fluctuations with HANK & SAM: An Analytical Approach," CEPR Discussion Papers 11696, C.E.P.R. Discussion Papers.
    7. Edouard Challe, 2017. "Uninsured Unemployment Risk and Optimal Monetary Policy," Working Papers 2017-54, Center for Research in Economics and Statistics.
    8. repec:aea:jecper:v:32:y:2018:i:3:p:87-112 is not listed on IDEAS
    9. repec:bla:econom:v:84:y:2017:i:336:p:820-831 is not listed on IDEAS
    10. Alisdair McKay & Emi Nakamura & Jón Steinsson, 2017. "The Discounted Euler Equation: A Note," Economica, London School of Economics and Political Science, vol. 84(336), pages 820-831, October.
    11. Ricardo J. Caballero & Alp Simsek, 2017. "A Risk-centric Model of Demand Recessions and Macroprudential Policy," NBER Working Papers 23614, National Bureau of Economic Research, Inc.
    12. Ralph Luetticke, 2018. "Transmission of Monetary Policy with Heterogeneity in Household Portfolios," Discussion Papers 1819, Centre for Macroeconomics (CFM).
    13. Andrea Colciago & Anna Samarina & Jakob de Haan, 2018. "Central bank policies and income and wealth inequality: A survey," DNB Working Papers 594, Netherlands Central Bank, Research Department.
    14. Galí, Jordi, 2018. "The State of New Keynesian Economics: A Partial Assessment," CEPR Discussion Papers 13095, C.E.P.R. Discussion Papers.
    15. Joshua K. Hausman & Johannes F. Wieland, 2015. "Overcoming the Lost Decades? Abenomics after Three Years," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 46(2 (Fall)), pages 385-431.
    16. Narayana Kocherlakota, 2016. "Fragility of Purely Real Macroeconomic Models," NBER Working Papers 21866, National Bureau of Economic Research, Inc.
    17. George-Marios Angeletos & Chen Lian, 2016. "Forward Guidance without Common Knowledge," NBER Working Papers 22785, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E0 - Macroeconomics and Monetary Economics - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:21448. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://edirc.repec.org/data/nberrus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.