Redistributive Implications of the Great Recession: The old lose a lot and the young might gain

Abstract

The recent economic downturn which occurred between the middle of 2007 and the first quarter of 2009 (the so-called Great Recession) has been the most severe since the Great Depression. Recently Glover, Heathcote, Krueger, and Rios-Rull (2011), among others, document some salient features about the Great Recession: Asset prices decline more than twice as much as wages, and older households suffer large welfare losses while young households lose less and might even benefit. In this paper, we construct stochastic general equilibrium models in which households are subject to aggregate shocks that affect both wages and asset prices. In our models, the elasticity which measures the magnitude of the decline in asset prices relative to output is shown to be greater than one, if the coefficient of relative risk aversion is greater than one. The model also predicts that the younger cohorts fare better than older cohorts when the equilibrium decline in asset prices is large relative to the decline in wages. Asset price declines hurt the old, who rely on asset sales to finance consumption, but benefit the young, who purchase assets at depressed prices. In the three-period overlappinggenerations economy, there exists a possibility for the young to be better off being born in a recession rather than in normal times. This upshot depends on the wealth distribution.