Macroeconomics and Household Heterogeneity

This Handbook of Macroeconomics chapter studies how, and by how much, household income, wealth, and preference heterogeneity amplify and propagate a macroeconomic shock, focusing on the U.S. Great Recession of 2007-2009. Using Panel Study of Income Dynamics (PSID) household-level panel data, the authors first document that net worth is far more concentrated than earnings, income, or consumption, that the bottom two wealth quintiles hold essentially no net worth yet account for roughly a quarter of aggregate consumption expenditure, and that during the Great Recession these wealth-poor households cut their consumption growth by more than their income-growth slowdown alone would predict – evidence the authors read as increased precautionary saving rather than mechanical hand-to-mouth behavior. They then build and calibrate several variants of a canonical Krusell-Smith-style heterogeneous-household real business cycle model, adding preference heterogeneity, persistent idiosyncratic earnings risk, a stylized life-cycle/retirement structure, and unemployment insurance to match the empirical wealth distribution, including its low tail. The central finding is that wealth inequality significantly amplifies the aggregate consumption response to a Great Recession-sized shock – but does so specifically when the distribution features a sufficiently large mass of low-net-worth households who are not simply hand-to-mouth but instead sharply raise their saving rate as the recession hits, both because some of them do lose their jobs and because others, still employed, save against the now-elevated risk of future job loss. The benchmark economy with realistic wealth inequality generates a consumption decline about 0.5 percentage points larger than a representative-agent economy; the paper further shows that the generosity of unemployment insurance has a two-fold and partially offsetting effect on this amplification – softening the consumption drop of a given household while also shifting the long-run wealth distribution toward higher net worth – and that when output is allowed to be partially demand-determined through an aggregate-demand externality, larger wealth inequality also deepens the output decline itself, giving social insurance an additional macro-stabilization role.

Dirk Krueger | Macro Paper Warehouse

Macroeconomics and Household Heterogeneity