Heterogeneity in Household Portfolios and its Implication for Fiscal and Monetary Policy

Abstract

A household's portfolio generally consists of non-tradable and tradable assets. The most important non-tradable asset is human capital. It is the primary source of income for most households and at the same time subject to substantial idiosyncratic shocks. The presence of such shocks gives rise to both precautionary savings and cross-sectional differences in holdings of tradable assets when markets are incomplete. Importantly, tradable assets vary in their degree of liquidity. This dissertation contributes to assessing the importance of household heterogeneity for business cycle dynamics and macroeconomic policy.<br /> The first chapter quantifies the importance of fluctuations in household income risk as a source of business cycles. Toward this end, we build a New Keynesian dynamic stochastic general equilibrium (DSGE) model with asset-market incompleteness, idiosyncratic income risk, and sticky prices. The novel feature of the model is to allow for portfolio choice between liquid and illiquid assets in a business-cycle framework. Fluctuations in income risk generate sizable swings in precautionary savings that have significant aggregate consequences. Households respond to higher income risk by increasing their savings, but importantly do so by hording liquid paper assets. Consequently, consumption and investment fall, which leads to sizable output losses in a demand-determined economy.<br /> The second chapter assess the importance of the distribution of liquid and illiquid assets for the transmission of monetary policy in a DSGE model with sticky prices and heterogeneity in household portfolios. The main finding is that the direct effect of changes in the path of the real interest rate on consumption and savings is lower than in a setup with complete markets. Monetary policy instead primarily works through indirect equilibrium effects on income. This leads to non-trivial interactions between the redistributive consequences of monetary policy and heterogeneity in household portfolios. I find that consumption becomes more volatile while the response of investment to monetary policy shocks is smaller.<br /> The third chapter proposes an alternative transmission mechanism for discretionary lump-sum transfers from the government to households. These so-called ``fiscal stimulus payments'' have been used by the U.S. government during the last two recessions in 2001 and 2008/2009. We find that transfers do not only work through the disposable income channel but also by positively affecting household liquidity. Transfers increase individual liquidity and debt finance enhances market liquidity. This has consequences when the government retires this debt. Then households shift their savings into the physical asset to retain their enhanced consumption-smoothing capacity. This leads to a prolonged increase in capital and output.