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Consumption Dynamics During the Great Recession

  • Joseph Vavra

    (University of Chicago)

  • David Berger

    (Yale University)

Business cycle models typically abstract from the distinction between durable and non-durable consumption. However, in the 2007 recession, durable expenditures fell by three times as much as GDP while non-durable expenditures fell by slightly less than GDP. We show that simple extensions of business cycle models (both with and without complete markets) that assume frictionless durable adjustment are no more successful at matching the behavior of consumption, as they imply a decline in durable expenditures that is too large and a decline in non-durable expenditures that is too small, relative to the recession. Motivated by micro evidence, we introduce fixed costs of durable adjustment into the incomplete markets model and show that the model is able to match the behavior of consumption in the most recent recession. Fixed costs dampen the volatility of durable expenditures and amplify the volatility of non-durable expenditures, as a large fraction of households hold wealth in illiquid durables. In addition, the model implies non-linear dynamics that are in line with time-series data: durable expenditures respond more strongly to shocks during booms than during recessions. Finally, we provide additional evidence that supports our model: using micro panel data we show that households with a large fraction of wealth in durables are less able to insure against income shocks.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 109.

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Date of creation: 2012
Date of revision:
Handle: RePEc:red:sed012:109
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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  1. John V. Leahy & Joseph Zeira, 2005. "The Timing of Purchases and Aggregate Fluctuations," Review of Economic Studies, Oxford University Press, vol. 72(4), pages 1127-1151.
  2. Maria J. Luengo-Prado, 2004. "Durables, Nondurables, Down Payments and Consumption Excesses," Macroeconomics 0408006, EconWPA.
  3. Matteo Iacoviello & Marina Pavan, 2011. "Housing and debt over the life cycle and over the business cycle," International Finance Discussion Papers 1032, Board of Governors of the Federal Reserve System (U.S.).
  4. Greg Kaplan & Giovanni L. Violante, 2009. "How Much Consumption Insurance Beyond Self-Insurance?," NBER Working Papers 15553, National Bureau of Economic Research, Inc.
  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. R?diger Bachmann & Ricardo J. Caballero & Eduardo M. R. A. Engel, 2013. "Aggregate Implications of Lumpy Investment: New Evidence and a DSGE Model," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(4), pages 29-67, October.
  7. Ben S. Bernanke, 1982. "Adjustment Costs, Durables, and Aggregate Consumption," NBER Working Papers 1038, National Bureau of Economic Research, Inc.
  8. Patrick Bajari & Phoebe Chan & Dirk Krueger & Daniel Miller, 2013. "A Dynamic Model Of Housing Demand: Estimation And Policy Implications," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 54(2), pages 409-442, 05.
  9. Antonia Díaz & María José Luengo-Prado, 2010. "The Wealth Distribution With Durable Goods," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(1), pages 143-170, 02.
  10. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  11. Martin Browning & Thomas Crossley, 2003. "Shocks, Stocks and Socks," Department of Economics Working Papers 2003-07, McMaster University.
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