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Wealth and Volatility

Author

Listed:
  • Fabrizio Perri

    (University of Minnesota)

  • Jonathan Heathcote

    (Federal Reserve Bank of Minneapolis)

Abstract

We document a strong negative relation in the United States between wealth and aggregate volatility. For example the 1970s and the late 2000s were periods of low asset values and high volatility. The early 1960s and the Great Moderation of the 1980s and 1990s were periods of high asset values and low volatility. Motivated by this fact, we develop a simple theoretical model that links asset values to the extent of business cycle fluctuations. In our environment economic fluctuations can be driven by fluctuations in household optimism or pessimism (animal spirits), as in traditional Keynesian frameworks. The new element is a precautionary motive in consumption demand, the strength of which varies with aggregate wealth and unemployment risk. This implies that fluctuations due to "animal spirits" (and hence the level of volatility) depend crucially on the value of wealth in the economy. When wealth is high the precautionary motive is weak and demand is not sensitive to change in expectations. In this case the economy has a “neo-classical†unique equilibrium and demand management is not effective as a stabilization policy. When wealth is low the economy is vulnerable to confidence shocks, high volatility is possible due to a multiplicity of equilibria, and there is a role for demand management.

Suggested Citation

  • Fabrizio Perri & Jonathan Heathcote, 2012. "Wealth and Volatility," 2012 Meeting Papers 914, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:914
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    Cited by:

    1. Krueger, D. & Mitman, K. & Perri, F., 2016. "Macroeconomics and Household Heterogeneity," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 843-921, Elsevier.
    2. Ricardo Reis & Alisdair McKay, 2015. "Optimal Automatic Stabilizers," 2015 Meeting Papers 608, Society for Economic Dynamics.
    3. Michael Olabisi, 2020. "Input–Output Linkages and Sectoral Volatility," Economica, London School of Economics and Political Science, vol. 87(347), pages 713-746, July.
    4. Pascal Michaillat & Emmanuel Saez, 2015. "Aggregate Demand, Idle Time, and Unemployment," The Quarterly Journal of Economics, Oxford University Press, vol. 130(2), pages 507-569.
    5. Philippe Bacchetta & Eric van Wincoop, 2016. "The Great Recession: A Self-Fulfilling Global Panic," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(4), pages 177-198, October.
    6. Roger Farmer, 2019. "The Importance of Beliefs in Shaping Macroeconomic Outcomes," NBER Working Papers 26557, National Bureau of Economic Research, Inc.
    7. Mark Garmaise & Yaron Levi & Hanno Lustig, 2020. "Spending Less After (Seemingly) Bad News," NBER Working Papers 27010, National Bureau of Economic Research, Inc.
    8. Mian, A. & Sufi, A., 2016. "Who Bears the Cost of Recessions? The Role of House Prices and Household Debt," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 255-296, Elsevier.
    9. Michaillat, Pascal & Saez, Emmanuel, 2013. "A Model of Aggregate Demand and Unemployment," CEPR Discussion Papers 9609, C.E.P.R. Discussion Papers.
    10. Matthew Rognlie & Adrien Auclert, 2016. "Inequality and Aggregate Demand," 2016 Meeting Papers 1353, Society for Economic Dynamics.
    11. Artur Rutkowski, 2019. "Evaluating an old-age voluntary saving scheme under incomplete rationality," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 3, pages 55-94.
    12. Hochmuth, Brigitte & Moyen, Stephane & Stähler, Nikolai, 2019. "Labor market reforms, precautionary savings, and global imbalances," Discussion Papers 13/2019, Deutsche Bundesbank.
    13. Tomáš Havránek & T. D. Stanley & Hristos Doucouliagos & Pedro Bom & Jerome Geyer‐Klingeberg & Ichiro Iwasaki & W. Robert Reed & Katja Rost & R. C. M. van Aert, 2020. "Reporting Guidelines For Meta‐Analysis In Economics," Journal of Economic Surveys, Wiley Blackwell, vol. 34(3), pages 469-475, July.
    14. Guo, Yumei & Huang, Xianjing & Peng, Yuchao, 2020. "How does house price influence monetary policy transmission?," International Review of Financial Analysis, Elsevier, vol. 72(C).
    15. Conchita D'Ambrosio & Giorgia Menta & Edward N. Wolff, 2019. "Income and Wealth Volatility: Evidence from Italy and the U.S. in the Past Two Decades," NBER Working Papers 26527, National Bureau of Economic Research, Inc.

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    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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