Labor Income Uncertainty and the Macroeconomy Christopher Carroll 1 - PowerPoint PPT Presentation

Labor Income Uncertainty and the Macroeconomy Christopher Carroll 1 Consumer Financial Protection Bureau Christopher.Carroll@cfpb.gov Presentation at “Uncertainty and the Macroeconomy” May 2014

US Personal Saving Rate ( s ), 1966–2011 14 12 10 Percent of Disposable Income 8 6 4 2 0 1970 1975 1980 1985 1990 1995 2000 2005 2010

Theory v ( m t ) = { c t , x t } u ( c t ) + β E t [ v ( m t +1 )] max s.t. = ζ R t +1 + (1 − ζ )R R t +1 = ( m t − x t − c t ) R t +1 + θ t +1 m t +1 ◮ Labor Income Uncertainty ◮ Unemployment Is Biggest Shock ◮ Lots of Micro Evidence that Precautionary Saving Is Big ◮ Basically, people facing greater σ : ◮ Don’t buy a house/car ( x = 0) ◮ Hold larger net worth ◮ Rate-Of-Return Uncertainty ◮ Theoretical effects on C ambiguous ◮ For plausible parameter values, σ ↑⇒ C ↑ ◮ Portfolio share in risky asset is reduced

Literature on C ◮ “Wealth Effects” ◮ Modigliani, Klein, MPS model, ... ◮ s t = − 0 . 05 m t + other stuff ◮ “Precautionary” ◮ Carroll (1992) ◮ Saving rate rises in recessions ◮ ∆ log C t +1 strongly related to E t ( u t +1 − u t ) ◮ “Credit Availability” ◮ Secular Trend: ◮ Parker (2000), Dynan and Kohn (2007), Muellbauer (many papers) ◮ Cyclical Dynamics: ◮ Guerrieri and Lorenzoni (2017), Eggertsson and Krugman (2012), Hall (2011)

Great Recession 2007–2009 ◮ s rises by ∼ 4 pp ◮ Bigger & more persistent increase than any postwar recession ◮ But all three indicators also move a lot: ◮ Credit conditions tighten ◮ Unemployment Expectations rise ◮ Wealth falls

Personal Saving Rate 2007– ↑ 6.00 Deviation from Start-of-Recession Value in % 4.00 2.00 0.00 -2.00 -4.00 0 2 4 6 8 10 12 14 16 18 20 Quarters after Start of Recession Historical Range Historical Mean 2007+

Saving Rate After a Permanent Rise in ℧  t ⟵ Overshooting ˇ   t ˇ  t Time t

Credit Easing/Financial Innovation & Deregulation  New  (  ) ⟶ ⟵ Orig  (  ) e = 0 ⟵ Δ  t + 1 ↖ Orig Target  -  m is close to linear in credit conditions ˇ

Net Worth (Ratio to Quarterly Disp Income) 6.5 6 5.5 5 4.5 4 1970 1975 1980 1985 1990 1995 2000 2005 2010

Credit Easing Accumulated (CEA) (` a la Muellbauer) Accumulated responses, weighted with debt–income ratio, to: “Please indicate your bank’s willingness to make consumer installment loans now as opposed to three months ago.” 1 0.8 0.6 0.4 0.2 0 1970 1975 1980 1985 1990 1995 2000 2005 2010

℧ t Implied by Michigan U Expectations UExp : “How about people out of work during the coming 12 months—do you think that there will be more unemployment than now, about the same, or less?” 10 8 6 4 2 1970 1975 1980 1985 1990 1995 2000 2005 2010

Reduced-Form Regressions s t = γ 0 + γ m m t + γ CEA CEA t + γ Eu E t u t +4 + γ t t + γ uC ( E t u t +4 × CEA t )+ ε t Model Time Wealth CEA Un Risk All 3 Baseline Interact 11 . 95 ∗∗∗ 25 . 20 ∗∗∗ 9 . 32 ∗∗∗ 8 . 24 ∗∗∗ 14 . 90 ∗∗∗ 15 . 23 ∗∗∗ 15 . 55 ∗∗∗ γ 0 (0 . 61) (1 . 73) (0 . 57) (0 . 42) (2 . 56) (2 . 16) (2 . 56) − 2 . 61 ∗∗∗ − 1 . 12 ∗∗∗ − 1 . 18 ∗∗∗ − 1 . 37 ∗∗∗ γ m (0 . 32) (0 . 42) (0 . 35) (0 . 46) − 14 . 14 ∗∗∗ − 5 . 47 ∗∗∗ − 6 . 12 ∗∗∗ − 4 . 60 ∗∗∗ γ CEA (1 . 74) (1 . 94) (0 . 57) (1 . 72) 0 . 67 ∗∗∗ 0 . 32 ∗∗∗ 0 . 29 ∗∗∗ 0 . 38 ∗∗∗ γ Eu (0 . 05) (0 . 12) (0 . 08) (0 . 11) − 0 . 04 ∗∗∗ − 0 . 03 ∗∗∗ − 0 . 05 ∗∗∗ − 0 . 00 0 . 04 ∗∗∗ 0 . 00 γ t (0 . 00) (0 . 00) (0 . 01) (0 . 00) (0 . 01) (0 . 01) − 0 . 32 ∗∗ γ uC (0 . 16) ¯ R 2 0 . 70 0 . 85 0 . 82 0 . 88 0 . 89 0 . 90 0 . 90 F stat p val 0 . 00 0 . 00 0 . 00 0 . 00 0 . 00 0 . 00 0 . 00 DW stat 0 . 30 0 . 69 0 . 50 0 . 86 0 . 94 0 . 93 0 . 98

PSR Forecasts—Out of Sample 2012–2015 8 8 (percent of disposable personal income) 6 6 4 4 Baseline Scenario Upside Risk Scenario 2 2 Downside Risk Scenario Fitted values of model 0 0 2005 2007 2009 2011 2013 2015 Scenarios based on SPF and our judgement

Conclusions ◮ All three effects present ◮ Easier borrowing largely explains secular decline s ◮ Order of importance in Great Recession: 1. Wealth shock 2. Labor income risk 3. Credit tightening ◮ ⇒ if credit has big cyclical effect, comes thru w and ℧

References Carroll, Christopher D. (1992): “The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence,” Brookings Papers on Economic Activity , 1992(2), 61–156, http://econ.jhu.edu/people/ccarroll/BufferStockBPEA.pdf . Dynan, Karen E., and Donald L. Kohn (2007): “The Rise in U.S. Household Indebtedness: Causes and Consequences,” International Finance Discussion Paper 37, Board of Governors of the Federal Reserve System. Eggertsson, Gauti B., and Paul Krugman (2012): “Debt, Deleveraging, and the Liquidity Trap: A Fisher–Minsky–Koo Approach,” The Quarterly Journal of Economics , 127(3), 1469–1513. Guerrieri, Veronica, and Guido Lorenzoni (2017): “Credit crises, precautionary savings, and the liquidity trap,” The Quarterly Journal of Economics , 132(3), 1427–1467. Hall, Robert E. (2011): “The Long Slump,” AEA Presidential Address, ASSA Meetings, Denver. Parker, Jonathan A. (2000): “Spendthrift in America? On Two Decades of Decline in the U.S. Saving Rate,” in NBER Macroeconomics Annual 1999, Volume 14 , NBER Chapters, pp. 317–387. National Bureau of Economic Research, Inc.

Background Slides

Alternative Measures of Credit Availability CEA/Debt−Income Ratio 0 .5 1 1.5 1970 1975 1980 1985 1990 1995 2000 2005 2010 .6 .7 .8 .9 1 Abiad et al. Index of Financial Liberalization

Assumptions/Scenarios for Out-of-Sample Forecasts Household net wealth Unemployment rate 700 700 12 12 (percent of disposable personal income) (percent of labor force) 650 650 10 10 600 600 550 550 8 8 500 500 Baseline scenario 6 6 Upside risk scenario 450 450 Downside risk Baseline scenario scenario Upside risk scenario Unemployment expectations Downside risk scenario 400 400 4 4 2005 2007 2009 2011 2013 2015 2005 2007 2009 2011 2013 2015 Credit conditions Household saving rate

Assumptions/Scenarios for Out-of-Sample Forecasts 2005 2007 2009 2011 2013 2015 2005 2007 2009 2011 2013 2015 Credit conditions Household saving rate 1.3 1.3 8 8 (percent of disposable personal income) Baseline scenario Upside risk scenario Downside risk scenario 1.2 1.2 6 6 1.1 1.1 1.0 1.0 4 4 0.9 0.9 2 2 Baseline Scenario Upside Risk Scenario 0.8 0.8 Downside Risk Scenario Fitted values of model Sources: Haver Analytics and authors' estimates. 0.7 0.7 0 0 2005 2007 2009 2011 2013 2015 2005 2007 2009 2011 2013 2015

Actual and Target Wealth 26 24 22 20 18 16 Actual Wealth Target Wealth 1970 1975 1980 1985 1990 1995 2000 2005 2010

Household Wealth 2007– ↓ by 150% of Income 100 Deviation from Start−of−Recession Value 50 0 −50 −100 −150 0 2 4 6 8 10 12 14 16 18 20 Quarters after Start of Recession Historical Range Historical Mean 2007−2009 Recession

Sustained Expectations of Rising Unemp Risk Thomson Reuters/University of Michigan E t ( u t +4 − u t ) 30 40 50 60 70 80 90 100 110 120 130 1970 1975 1980 1985 1990 1995 2000 2005 2010

Tighter HH Credit Supply (Based on Muellbauer) 1 0.8 0.6 0.4 0.2 0 1970 1975 1980 1985 1990 1995 2000 2005 2010

Consumption Function e   e = 0 ⟶ Δ  + 1 SS ↘ e = 0 ↘ Δ  + 1  e (  )= Stable Arm ⟶ e  

Overshooting and Fiscal Policy DSGE models: ◮ Frictions, frictions everywhere; but missing here ◮ If ∆ c imposes ‘external’ costs ◮ Sticky prices/wages ◮ Capital (or Investment) adjustment costs ◮ Other reasons for ‘pecuniary externalities’ ◮ ⇒ ‘stimulus’ payments, fiscal policy may reduce cost of cycle ◮ Justification for ‘automatic stabilizers’?

Reduced-Form Regressions on Model Data s theor = γ 0 + γ m m t + γ CEA CEA t + γ Eu E t u t +4 + γ t t + γ uC ( E t u t +4 × CEA t )+ ε t t Model Time Wealth CEA Un Risk All 3 Baseline Interact 11 . 96 ∗∗∗ 21 . 44 ∗∗∗ 9 . 35 ∗∗∗ 8 . 42 ∗∗∗ 12 . 24 ∗∗∗ 12 . 51 ∗∗∗ 12 . 49 ∗∗∗ γ 0 (0 . 50) (1 . 11) (0 . 41) (0 . 16) (0 . 60) (0 . 53) (0 . 55) − 2 . 33 ∗∗∗ − 0 . 79 ∗∗∗ − 0 . 85 ∗∗∗ − 0 . 94 ∗∗∗ γ m (0 . 25) (0 . 12) (0 . 10) (0 . 11) − 13 . 82 ∗∗∗ − 5 . 85 ∗∗∗ − 6 . 49 ∗∗∗ − 5 . 33 ∗∗∗ γ CEA (1 . 12) (0 . 59) (0 . 14) (0 . 47) 0 . 63 ∗∗∗ 0 . 33 ∗∗∗ 0 . 30 ∗∗∗ 0 . 37 ∗∗∗ γ Eu (0 . 02) (0 . 04) (0 . 02) (0 . 03) − 0 . 04 ∗∗∗ − 0 . 03 ∗∗∗ − 0 . 05 ∗∗∗ − 0 . 00 0 . 04 ∗∗∗ 0 . 00 γ t (0 . 00) (0 . 00) (0 . 01) (0 . 00) (0 . 00) (0 . 00) − 0 . 19 ∗∗∗ γ uC (0 . 04) ¯ R 2 0 . 80 0 . 93 0 . 93 0 . 98 0 . 99 0 . 99 0 . 99 F stat p val 0 . 00 0 . 00 0 . 00 0 . 00 0 . 00 0 . 00 0 . 00 DW stat 0 . 05 0 . 22 0 . 09 0 . 39 0 . 72 0 . 71 0 . 99