By Andrew Glover, Jonathan Heathcote, Dirk Krueger and José-Víctor Ríos-Rull
In this paper we construct a stochastic overlapping-generations general equilibrium model in which households are subject to aggregate shocks that affect both wages and asset prices. We use a calibrated version of the model to quantify how the welfare costs of severe recessions are distributed across different household age groups. The model predicts that younger cohorts fare better than older cohorts when the equilibrium decline in asset prices is large relative to the decline in wages, as observed in the data. Asset price declines hurt the old, who rely on asset sales to finance consumption, but benefit the young, who purchase assets at depressed prices. In our preferred calibration, asset prices decline more than twice as much as wages, consistent with the experience of the US economy in the Great Recession. A model recession is approximately welfare-neutral for households in the 20-29 age group, but translates into a large welfare loss of around 10% of lifetime consumption for households aged 70 and over.
This is sad to say, but this has been an interesting recession. While usually the young suffer the most in a recession due to the lack of job prospects when they enter the labor market, and it was certainly even worse this time, the old were hit by a substantial asset loss. It is then not clear who lost the most, or even whether the young lost, as they find cheap assets at the age when real estate is usually unavailable to them. This papers sorts this carefully out, and the older generation is right to be unhappy about its situation.