Unemployment risk, consumption dynamics, and the secondary market for durable goods

Abstract

I provide a theoretical framework of optimal purchases of new and used consumer durables in an economy with heterogeneous agents, idiosyncratic income risk and incomplete financial markets. Agents choose optimally between consuming nondurable and durable goods and accumulating a risk-free asset. The price of durable goods in the secondary market is determined endogenously, through market clearing. The model generates pro-cyclical durable expenditures and (resale) prices, which is consistent with the available empirical evidence for the US economy. The mechanism behind this result is that, following increases in unemployment risk during recessions, durable goods become less attractive to households, which rebalance their portfolio towards liquid asset holdings. This decreases the demand for durable goods and exerts a downward pressure on their price. I show that the illiquidity associated to durable accumulation is key in generating the results. The benefits of extending income support to unemployed households during recessions are studied in a policy experiment.