Tightening financial frictions on households, recessions, and price reallocations

Zhen Huo, Victor Rios-Rull

Research output: Contribution to journalArticlepeer-review

4 Scopus citations

Abstract

We explore the effects of financial shocks in heterogeneous agent economies with aggregate savings and with frictions in some consumption markets, where demand contributes to productivity. Households of various wealth and earnings levels search for goods at different intensities and pay different prices in differently crowded markets. Increases in savings arising from a financial shock that tightens the borrowing limit trigger a recession via two channels: 1) the reduction in the consumption of goods that are subject to search frictions reduces productivity and output; 2) because the poorest households are more affected by the shock, consumption tilts toward the richest households, causing an additional reduction in output and productivity. We model fixed prices in a competitive search environment and show how price rigidities dramatically exacerbate the recession.

Original languageEnglish (US)
Pages (from-to)118-139
Number of pages22
JournalReview of Economic Dynamics
Volume18
Issue number1
DOIs
StatePublished - Jan 1 2015

Bibliographical note

Funding Information:
Ríos-Rull thanks the National Science Foundation for Grant SES-1156228 . We are thankful for discussions with Yan Bai, Kjetil Storesletten, and Nir Jaimovich. We also thank Sebastian di Tella for his discussion at the St. Louis Review of Economic Dynamics Special Issue Conference which greatly improved the paper, and to the organizers of the conference and editors of the special issue, Mark Gertler and Steve Williamson. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.

Publisher Copyright:
© 2014 Elsevier Inc.

Copyright:
Copyright 2015 Elsevier B.V., All rights reserved.

Keywords

  • Credit crunch
  • Endogenous productivity
  • Household heterogeneity
  • Price dispersion

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