Electronic Thesis and Dissertation Repository

Thesis Format

Integrated Article

Degree

Doctor of Philosophy

Program

Economics

Supervisor

Stephen Williamson

Abstract

My dissertation consists of three essays on Macroeconomics. In the first two chapters, I study the implications of uncertain expenses for households' savings and for their consumption adjustment in response to monetary policy. In the third chapter, I study how asset liquidity affects households’ ability to smooth idiosyncratic income shocks.

In the first chapter, I characterize uncertain expenses using U.S. Consumer Expenditure Survey data. Here, my goals are twofold. First, I classify households’ spending that captures uncertainties in expenses (for example, car and home repairs or out-of-pocket medical expenses) and measure their overall importance. Second, I aim to understand how households adjust expenditures in response to monetary policy. I find that uncertain expenses represent 14.5% of total expenditures for a typical household in the U.S. and display significantly larger fluctuations than other expenses. I further show that uncertain expenses drive 41.8% of households' short-run consumption adjustment in response to monetary policy.

In the second chapter, I develop a model to study the quantitative importance of uncertain expenses for households' savings, especially for portfolio choice among assets with different liquidity, and examine monetary policy implications. The model features heterogeneous agents with incomplete markets for two assets, a low-return/liquid asset (money) and a high-return/illiquid asset (bonds). Households can use these assets to self-insure idiosyncratic risk with respect to both income and expenses. Due to frictions in the goods market and in the portfolio choice problem, self-insurance against expenditure risk is a significant driver of money demand and household portfolio rebalancing explains 80% of households’ short-run adjustment in uncertain expenses in response to monetary policy. In addition, the model is consistent with the high level of concentration in the distribution of money holdings observed in the data, a feature hard to explain with traditional transaction motives for money demand.

In the third chapter, I study how asset market illiquidity affects risk-sharing among asset holders. I build a model where assets are traded subject to search and matching frictions with the transaction price determined as the solution to a bargaining problem between buyers and sellers. In addition, matching efficiency in this market endogenously determines the degree of asset illiquidity. After a loss in liquidity, the pricing mechanism derived from the bargaining problem tightens the budget constraint for sellers of the asset, who can then finance less consumption. Consequently, the consumption wedge between asset holders increases, and there is a deviation from perfect risk sharing.

Summary for Lay Audience

In the first two chapters, I study how monetary policy affects households’ ability to meet uncertain expenses, like car and home repairs or out-of-pocket medical expenses. I show that self-insurance motives against expenditure risk imply a novel direct channel for the transmission of monetary policy to consumption. The mechanism operates through households’ optimal portfolio rebalancing, among assets with different liquidity (and different returns), in response to changes in the policy rate.

The main contributions are the following. First, I empirically document that the basket of uncertain expenses is highly sensitive to changes in the policy rate, accounting for almost half of households’ short-run consumption adjustment in response to monetary policy shocks (in the form of unanticipated adjustments in the policy rate). Second, I propose a novel transmission channel for monetary policy to explain these empirical results, in which the key mechanism operates through household portfolio rebalancing. Third, I show how this channel works in a quantitative macroeconomic model and find that it explains 80% of households’ adjustment in uncertain expenses. Overall, this allows us to refine our understanding of the channels through which monetary policy operates. In particular, on both this rebalancing channel and the speed of the transmission of monetary policy, since this rebalancing channel operates in the quarters immediately after a policy change, affecting the short-run response of consumption.

Last, in the third chapter, I study how lower asset liquidity due to search frictions, affects households’ ability to smooth idiosyncratic income fluctuations.

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