Staff Report 508

Wealth and Volatility

Jonathan Heathcote | Monetary Advisor
Fabrizio Perri | Monetary Advisor

Revised July 7, 2015

In the United States, periods of low household wealth have also been periods of high macroeconomic volatility. Our candidate explanation is that low wealth opens the door to self-fulfilling fluctuations. If wealth poor households expect high unemployment, they have a strong precautionary incentive to cut spending, making the expectation of high unemployment a reality. We first document that poor U.S. households cut spending during the Great Recession much more sharply than richer households, consistent with a precautionary interpretation. We then develop a macroeconomic model featuring unemployment risk, and study the link between asset values and the volatility and persistence of precaution-driven fluctuations.

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