Precautionary Saving and Aggregate Demand

By Edouard Challe, Julien Matheron, Xavier Ragot and Juan F. Rubio-Ramirez

http://d.repec.org/n?u=RePEc:bfr:banfra:535&r=dge

We formulate and estimate a tractable macroeconomic model with time-varying precautionary savings. We argue that the latter affect aggregate fluctuations via two main channels: a stabilizing aggregate supply effect working through the supply of capital; and a destabilizing aggregate demand effect generated by a feedback loop between unemployment risk and consumption demand. Using the estimated model to measure the contribution of precautionary savings to the propagation of recent recessions, we find strong aggregate demand effects during the Great Recession and the 1990–1991 recession. In contrast, the supply effect at least offset the demand effect during the 2001 recession.

One much-neglected aspect of the recent recession is how households suddenly started saving more. This paper puts such behavior in the heart of the model and gets interesting results from it. Beyond the headline that the demand effects of precautionary savings were most important in the Great Recession, the model is also interesting because it has a lot of potential in explaining distributional aspects of recessions. Could it even explain long-term trends in the distribution of assets? Probably not without more institutional detail.

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