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Cyclical Risk Aversion, Precautionary Saving, and Monetary Policy

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  • BIANCA DE PAOLI
  • PAWEL ZABCZYK

Abstract

This paper analyzes the conduct of monetary policy in an environment in which cyclical swings in risk appetite affect households’ propensity to save. It uses a New Keynesian model featuring external habit formation to show that taking note of precautionary saving motives justifies an accommodative policy bias in the face of persistent, adverse disturbances. Equally, policy should be more restrictive—that is “lean against the wind”—following positive shocks. Under sufficiently persistent habits it is, in fact, optimal to increase interest rates following a rise in productivity.

Suggested Citation

  • Bianca De Paoli & Pawel Zabczyk, 2013. "Cyclical Risk Aversion, Precautionary Saving, and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(1), pages 1-36, February.
    • Handle: RePEc:wly:jmoncb:v:45:y:2013:i:1:p:1-36
    DOI: 10.1111/j.1538-4616.2012.00560.x
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    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. 'Risk Aversion and the Natural Interest Rate'
      by Mark Thoma in Economist's View on 2014-07-16 13:21:30
    2. Risk Aversion and the Natural Interest Rate
      by Blog Author in Liberty Street Economics on 2014-07-16 16:00:00
    3. Should Monetary Policy Respond to Financial Conditions?
      by Blog Author in Liberty Street Economics on 2015-11-16 18:00:00

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    3. Bonciani, Dario, 2014. "Uncertainty shocks: it's a matter of habit," MPRA Paper 59370, University Library of Munich, Germany.
    4. Martin Seneca, 2020. "Risk Shocks and Monetary Policy in the New Normal," International Journal of Central Banking, International Journal of Central Banking, vol. 16(6), pages 185-232, December.
    5. Seneca, Martin, 2016. "Risk shocks close to the zero lower bound," Bank of England working papers 606, Bank of England.
    6. James D. Hamilton & Ethan S. Harris & Jan Hatzius & Kenneth D. West, 2016. "The Equilibrium Real Funds Rate: Past, Present, and Future," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 64(4), pages 660-707, November.
    7. Bingbing Dong, 2014. "Asset Pricing and Monetary Policy," 2014 Meeting Papers 881, Society for Economic Dynamics.
    8. Bianca De Paoli & Jens Søndergaard, 2017. "Revisiting the Forward Premium Anomaly Using Consumption Habits: A New Keynesian Model," Economica, London School of Economics and Political Science, vol. 84(335), pages 516-540, July.
    9. Hatcher, Michael, 2011. "Time-varying volatility, precautionary saving and monetary policy," Bank of England working papers 440, Bank of England.
    10. Heipertz, Jonas & Mihov, Ilian & Santacreu, Ana Maria, 2022. "Managing macroeconomic fluctuations with flexible exchange rate targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 135(C).
    11. Michael Hatcher, 2013. "The inflation risk premium on government debt in an overlapping generations model," Working Papers 2013_17, Business School - Economics, University of Glasgow.
    12. Huidrom, Raju & Kose, M. Ayhan & Lim, Jamus J. & Ohnsorge, Franziska L., 2020. "Why do fiscal multipliers depend on fiscal Positions?," Journal of Monetary Economics, Elsevier, vol. 114(C), pages 109-125.
    13. Kranz Tobias, 2017. "Calibrating the Equilibrium Condition of a New Keynesian Model with Uncertainty," Review of Economics, De Gruyter, vol. 68(2), pages 117-151, August.
    14. De Luigi, Clara & Huber, Florian, 2018. "Debt regimes and the effectiveness of monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 218-238.
    15. John H. Cochrane, 2017. "Macro-Finance," Review of Finance, European Finance Association, vol. 21(3), pages 945-985.
    16. Łukasz Rawdanowicz & Romain Bouis & Kei-Ichiro Inaba & Ane Kathrine Christensen, 2014. "Secular Stagnation: Evidence and Implications for Economic Policy," OECD Economics Department Working Papers 1169, OECD Publishing.
    17. Yadav, Jayant, 2020. "Flight to Safety in Business cycles," MPRA Paper 104093, University Library of Munich, Germany.
    18. Thiago Revil T. Ferreira & Samer Shousha, 2021. "Supply of Sovereign Safe Assets and Global Interest Rates," International Finance Discussion Papers 1315, Board of Governors of the Federal Reserve System (U.S.).
    19. Andersson, Magnus & D'Agostino, Antonello & de Bondt, Gabe & Roma, Moreno, 2011. "The predictive content of sectoral stock prices: a US-euro area comparison," Working Paper Series 1343, European Central Bank.

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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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