Does Unemployment Risk Affect Business Cycle Dynamics?
Abstract: In this paper, I show that the decline in household consumption during unemployment spells depends on both liquid and illiquid asset positions. I also provide evidence that unemployment spells predict the withdrawal of illiquid assets, particularly when households have few liquid assets. Motivated by these findings, I embed endogenous unemployment risk in a two-asset heterogeneous-agent New Keynesian model. The model is consistent with the above evidence and provides a new propagation mechanism for aggregate shocks due to a flight-to-liquidity that occurs when unemployment risk rises. This mechanism implies that unemployment insurance plays an important role as an automatic stabilizer, particularly when monetary policy is constrained.
File(s): File format is application/pdf https://www.federalreserve.gov/econres/ifdp/files/ifdp1298.pdf
Part of Series: International Finance Discussion Papers
Publication Date: 2020-09-18