Time-Varying Employment Risks and Consumption: A Quantitative General Equilibrium Study

Abstract

This paper quantifies the effect of time-varying employment risks on the fluctuations of aggregate consumption in a dynamic general equilibrium with incomplete markets. A government's redistribution policy through provision of unemployment insurance can cause a positive correlation between aggregate consumption and government's payments due to precautionary savings effects. The underlying mechanism is that a reduction of unemployment risk increases expected lifetime income substantially across a wide range of asset-holding groups when the risk reduction is sufficiently persistent. By contrast, the correlation between consumption and government becomes negative when government intervention hampers supply of goods.Time-varying idiosyncratic risk, employment risk, precautionary savings, regime-switching fiscal policy