Price Variability and Savings

Abstract

We analyze how commodity price variability affects saving behavior in a dynamic model with multiple commodities, portfolio hedging, and a preference structure that disentangles attitudes towards risk and attitudes towards intertemporal substitution. We show that the effect of price variability on savings boils down to knowing 1) the consumer’s degree of aversion to intertemporal fluctuations (i.e. the size of the elasticity of intertemporal substitution) and 2) the effect that price variability has on the certainty-equivalent real interest rate. Price variability is more likely to decrease the certainty-equivalent rate if consumers are highly risk averse, if there is limited intra-temporal substitution among the goods, and if asset returns are a poor hedge against inflation. We also show that if price variability decreases the certainty-equivalent rate, consumer’s welfare also decreases.