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Precautionary Saving and Aggregate Demand

Listed author(s):
  • Julien Matheron

    (Banque de France)

  • Juan Rubio-Ramirez

    (Duke University)

  • Edouard Challe

    (Ecole Polytechnique)

  • Xavier Ragot

    (Paris School of Economics)

This paper introduces incomplete insurance against idioyncratic labour income risk into an otherwise standard New Keynesian business cycle model with involuntary unemployment. Following an adverse monetary policy shock that lowers aggregate demand, job creation is discouraged and unemployment risk persistently rises. Imperfectly insured households rationally respond to the rise in idiosyncratic income uncertainty by increasing precautionary saving, thereby cutting consumption and depleting aggregate demand even further; this in turn magnifies the initial labour market contraction and further raises unemployment risk. A Bayesian estimation of the model is used to assess the contribution of time-varying precautionary saving to movements in aggregate consumption.

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File URL: https://economicdynamics.org/meetpapers/2014/paper_1021.pdf
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Paper provided by Society for Economic Dynamics in its series 2014 Meeting Papers with number 1021.

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Date of creation: 2014
Handle: RePEc:red:sed014:1021
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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