Relative Volatility Of Consumption Research Articles

A New angle on excess consumption volatility in emerging countries: Does house price matter?

This paper focuses on house prices in order to explain excess consumption volatility, which is one of the stylized facts of the business cycle observed in emerging countries. The relative consumption volatility compared to output volatility is higher in emerging countries than in rich countries. Because house prices in emerging countries are more volatile than in advanced countries, this paper suggests a new angle focusing on relationship between house price fluctuation and excess consumption volatility. To begin, I construct a cross-country dataset, and suggest new evidence that house prices are more correlated with consumption in the case of emerging countries compared to rich countries while the correlation between house prices and output are similar between two country groups. Then, I build business cycle models given exogenous house price and output processes in order to explain excess consumption volatility puzzle. The results of the models suggest that high house price volatility in emerging countries causes their excess consumption volatility and that the mechanisms behind it are housing collateral effects and rental price pass-through. The former is related to the borrowing capacity affected by house price changes, and the latter is related to the link between house prices and housing consumption volatility.

Lending Standards and Borrowing Premia in Unsecured Credit Markets

<ns2:p>Using administrative data from Y-14M and Equifax, we find evidence for large spreads in excess of those implied by default risk in the U.S. unsecured credit market. These borrowing premia vary widely by borrower risk and imply a nearly flat relationship between loan prices and repayment probabilities, at odds with existing theories. To close this gap, we incorporate supply frictions – a tractably specified form of lending standards – into a model of unsecured credit with aggregate shocks. Our model matches the empirical incidence of both risk and borrowing premia. Both the level and incidence of borrowing premia shape individual and aggregate outcomes. Our baseline model with empirically consistent borrowing premia features 45% less total credit balances and 30% more default than a model with no such premia. In terms of dynamics, we estimate that lending standards were unchanged for low risk borrowers but tightened for high risk borrowers at the outset of Covid-19. Borrowing premia imply a smaller increase in credit usage in response to a negative shock, which this tightening reduced further. Since spreads on loans of all risk levels are countercyclical, all consumers use less unsecured credit for insurance over the cycle, leading to 60% higher relative consumption volatility than in a model with no borrowing premia.</ns2:p>

Income Risks and Optimal Attention-Consumption Allocation

This paper studies how agents allocate their limited attention between capital income and labor income risks in a two-period consumption-saving model with recursive utility. Specifically, we examine how the optimal attention and consumption-saving decisions are affected by the key model elements including the attention and wealth endowments, the risk and time preferences, and the amount of income risks. We also find that the simple model can have the potential to explain the consumption responses to the income risks and the relative volatility of consumption to income observed in the U.S. economy. Finally, we find that the welfare losses due to limited attention are insignificant.

INTERNATIONAL BUSINESS CYCLES IN EMERGING MARKETS

AbstractI document cyclical behavior of real exchange rates (RERs) in emerging and developed economies: stronger RER procyclicality coincides with larger relative volatility of consumption and more countercyclical trade balance. I then reevaluate the sources of fluctuations in emerging economies using an international business cycle model estimated to match the behavior of the RERs. Interest rate shocks, without any frictions, account for most of output fluctuations. This result is driven by imperfect substitution between domestic and foreign goods, which dampens the impact of trend shocks and accentuates the impact of interest rate shocks on output and consumption.

Business cycles, informal economy, and interest rates in emerging countries

This paper recognizes the importance of a large informal economy and interest rate fluctuations for business cycles in emerging countries. I document (1) a positive relationship between the relative volatility of consumption to output and the size of the informal economy, and (2) countercyclical interest rates in emerging countries. I show that in a two-sector real business cycle model of a small open economy with a poorly measured informal sector, an increase in country interest rate generates a contraction in output, consumption, investment, hours, an improvement in trade balance-to-output ratio, and an expansion of informal sector.

The price of imported capital and consumption fluctuations in emerging economies

We study the role played by fluctuations in the price of imported capital in determining the behavior of consumption fluctuations in developing countries. For this, we decompose the price of imported capital into common and country-specific components, where the common component is the price of capital in the US. Empirically, we document that, in contrast to small industrialized countries, consumption in developing countries responds more than output to unexpected changes in the price of capital in the US. As such, fluctuations in the price of capital in the US contribute to a high volatility of consumption relative to that of output in developing countries. We then show that a small open-economy real business cycle model driven by fluctuations in the price of imported capital can account for the responses of consumption and output to innovations of the price of capital in the US and for the high relative volatility of consumption observed in developing country. Finally, confronting the model to the data, we further find that fluctuations in the price of capital in the US contribute substantially to fluctuations of consumption in countries that display a low volatility of output and a large relative volatility of consumption.

Business Cycles, Informal Economy, and Interest Rates in Emerging Countries

This paper recognizes the importance of a large informal economy and interest rate fluctuations for business cycles in emerging countries. I document (1) a positive relationship between the relative volatility of consumption to output and the size of the informal economy, and (2) countercyclical interest rates in emerging countries. I show that in a two-sector real business cycle model of a small open economy with a poorly measured informal sector, an increase in country interest rate generates a contraction in output, consumption, investment, hours, an improvement in trade balance-to-output ratio, and an expansion of informal sector.

Financial Inclusion, Productivity Shocks, and Consumption Volatility in Emerging Economies

How does access to finance impact consumption volatility? Theory and evidence from advanced economies suggests that greater household access to finance smooths consumption. Evidence from emerging markets, where consumption is usually more volatile than income, indicates that financial reform further increases the volatility of consumption relative to output. This puzzle is addressed in the framework of an emerging economy model in which households face shocks to trend growth rate, and a fraction of them are financially constrained, with no access to financial services. Unconstrained households can respond to shocks to trend growth by raising current consumption more than the rise in current income. Financial reform increases the share of such households, leading to greater relative consumption volatility. Calibration of the model for pre- and post–financial reform in India provides support for the model's key predictions.

Robust control, informational frictions, and international consumption correlations

In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in an otherwise standard small open economy model with endogenous capital accumulation. We show that in the presence of capital mobility in financial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to productivity shocks across countries facing different macroeconomic uncertainty. In addition, we show that RB can also improve the model's predictions in three other moments of consumption dynamics: the relative volatility of consumption to income, the persistence of consumption, and the correlation between consumption and output. After calibrating the RB parameter using the detection error probabilities, we show that the model can explain the observed international consumption correlations as well as the other consumption moments quantitatively. Finally, we show that the main conclusions of our benchmark model do not change in an extension in which the agent cannot observe the state perfectly due to finite information-processing capacity.

Informality, financial development and macroeconomic volatility

In a dynamic stochastic general equilibrium model with heterogeneous agents, this note shows that beyond a certain low level, financial development is associated with higher relative consumption–income volatility in the presence of a working capital constraint. Informality on the other hand lowers relative consumption volatility by weakening the working capital requirement channel of financial development.

Credit Constraints, Productivity Shocks and Consumption Volatility in Emerging Economies

How does access to credit impact consumption volatility? Theory and evidence from advanced economies suggests that greater household access to finance smooths consumption. Evidence from emerging markets, where consumption is usually more volatile than income, indicates that financial reform further increases the volatility of consumption relative to output. We address this puzzle in the framework of an emerging economy model in which households face shocks to trend growth rate, and a fraction of them are credit constrained. Unconstrained households can respond to shocks to trend growth by raising current consumption more than rise in current income. Financial reform increases the share of such households, leading to greater relative consumption volatility. Calibration of the model for pre and post financial reform in India provides support for the model's key predictions.

Credit Constraints, Productivity Shocks and Consumption Volatility in Emerging Economies

How does access to credit impact consumption volatility? Theory and evidence from advanced economies suggests that greater household access to finance smooths consumption. Evidence from emerging markets, where consumption is usually more volatile than income, indicates that financial reform further increases the volatility of consumption relative to output. We address this puzzle in the framework of an emerging economy model in which households face shocks to trend growth rate, and a fraction of them are credit constrained. Unconstrained households can respond to shocks to trend growth by raising current consumption more than rise in current income. Financial reform increases the share of such households, leading to greater relative consumption volatility. Calibration of the model for pre and post financial reform in India provides support for the model's key predictions.

Has India emerged? Business cycle stylized facts from a transitioning economy

This paper presents a comprehensive set of stylized facts for business cycles in India from 1950 to 2010. We show that most macroeconomic variables are less volatile in the post reform period, even though the volatility of macroeconomic variables is still high and similar to other emerging market economies. Consistent with other emerging market economies, relative consumption volatility has gone up in the post reform period. In terms of co-movement and persistence however, India looks similar to advanced economies, and less like other emerging market economies. We report evidence that these changes are driven primarily by structural changes caused by market oriented reforms, and not by “good luck.”

Robustness, information–processing constraints, and the current account in small open economies

In this paper we examine the effects of two types of “induced uncertainty”, model uncertainty due to robustness (RB) and state uncertainty due to finite information–processing capacity (called rational inattention or RI), on consumption and the current account. We show that the combination of RB and RI improves the model's predictions for (i) the contemporaneous correlation between the current account and income and (ii) the volatility and persistence of the current account in small open emerging and developed economies. In addition, we show that the two informational frictions improve the model's ability to match the impulse response of consumption to income and the relative volatility of consumption to income growth.

Expected Inflation, Sunspots Equilibria and Persistent Unemployment Fluctuations

We propose and estimate a model where unemployment fluctuations result from self-fulfilling changes in expected inflation (sunspot shocks) affecting nominal wage bargaining. Since the estimated parameters fall near the locus of Hopf bifurcations, country-specific expected inflation shocks can replicate the strong persistence and heterogeneity observed in European unemployment rates. They also generate positive comovements in macroeconomic variables and a large relative volatility of consumption. All these features, hardly accounted for by standard sunspot-driven models, are explained here by the fact that liquidity constrained workers, facing earnings uncertainty in the context of imperfect unemployment insurance, choose to consume their current income.

Consumption dynamics under information processing constraints

This paper studies how “rational inattention” (RI)—a type of information processing constraint proposed by Sims [Sims, C.A., 2003. Implications of rational inattention, Journal of Monetary Economics 50 (3), 665–690]—affects the joint dynamics of consumption and income in a permanent income model with general income processes. Specifically, I propose an analytical approach to solve the multivariate permanent income model with RI and examine its implications for optimal consumption, saving, and welfare. It is shown that RI can affect the relative volatility of consumption and provide an endogenous propagation mechanism that disentangles the short-run and long-run responses of consumption to exogenous income shocks. I also explore how aggregation reduces the impact of the RI-induced endogenous noise on consumption and thus increases the smoothness of aggregate consumption. Finally, I compare RI with four alternative hypotheses (habit formation, signal extraction, robustness, and inattentiveness) by examining their implications for the joint behavior of consumption and income.

Financial Integration in East Asia

This paper examines the degree of integration into world financial markets and the impacts on several key macroeconomic variables of selected East Asian economies, and draws policy implications. According to our analysis, the degrees of integration into world financial markets in those economies are increasing. Regarding the impacts of increasing integration into world financial markets on several macroeconomic variables, we find three results. First, casual two-way plots among macroeconomic variables do not support the theoretical prediction of reduction in relative consumption volatility. Second, the saving-investment correlation is higher than those of the euro area economies. Third, the degrees of smoothing of idiosyncratic shock by cross-holding of financial assets are lower than in the euro area economies. These results suggest two policy implications. First, there is some room for improvement in welfare gains in those economies by means of further risk sharing. Second, holding all other conditions equal, the increasing integration into world financial markets alone is unlikely to provide sound grounds for a currency union in East Asia at this stage.

Financial Integration and Macroeconomic Volatility

This paper examines the impact of international financial integration on macroeconomic volatility. Economic theory does not provide a clear guide to the effects of financial integration on volatility, implying that this is essentially an empirical question. We provide a comprehensive examination of changes in macroeconomic volatility in a large group of industrial and developing economies over the period 1960-99. We report two major results: First, while the volatility of output growth has, on average, declined in the 1990s relative to the three earlier decades, we also document that, on average, the volatility of consumption growth relative to that of income growth has increased for more financially integrated developing economies in the 1990s. Second, increasing financial openness is associated with rising relative volatility of consumption, but only up to a certain threshold. The benefits of financial integration in terms of improved risk-sharing and consumption smoothing possibilities appear to accrue only beyond this threshold.

Financial Integration and Macroeconomic Volatility

This paper examines the impact of international financial integration on macroeconomic volatility in a large group of industrial and developing economies over the period 1960-99. We report two major results: First, while the volatility of output growth has, on average, declined in the 1990s relative to the three preceding decades, we also document that, on average, the volatility of consumption growth relative to that of income growth has increased for more financially integrated developing economies in the 1990s. Second, increasing financial openness is associated with rising relative volatility of consumption, but only up to a certain threshold. The benefits of financial integration in terms of improved risk-sharing and consumption-smoothing possibilities appear to accrue only beyond this threshold.

Financial Integration and Macroeconomic Volatility

This paper examines the impact of international financial integration on macroeconomic volatility in a large group of industrial and developing economies over the period 1960-99. We report two major results: First, while the volatility of output growth has, on average, declined in the 1990s relative to the three preceding decades, we also document that, on average, the volatility of consumption growth relative to that of income growth has increased for more financially integrated developing economies in the 1990s. Second, increasing financial openness is associated with rising relative volatility of consumption, but only up to a certain threshold. The benefits of financial integration in terms of improved risk-sharing and consumption-smoothing possibilities appear to accrue only beyond this threshold.