Aggregate Precautionary Savings Motives

This paper studies households' precautionary savings when they face macroeconomic shocks, a channel that complements the traditional microeconomic precautionary savings motive. I incorporate continuous aggregate income and credit supply shocks, two prominent sources of risk, into a Bewley-Huggett-Aiyagari model calibrated to the U.S. economy. I then propose a novel solution method that quantifies if and how much the economy departs from certainty equivalence. The precautionary motive associated with movements in credit supply is substantial. Its negative effect on the equilibrium risk-free rate is one fourth as large as for idiosyncratic income changes, and much larger than for aggregate income changes. Therefore, in the long-run, large movements in credit generate a low risk-free rate, low debt environment like the post-Great Recession period. They persistently, albeit mildly, depress consumption and employment, leading to higher estimates of the costs of business cycles. Over time, the model assigns about half of the volatility of consumption and the risk-free rate to credit supply shocks. When inverted to recover the sequence of structural shocks around the Great Recession, it suggests that households' borrowing constraints have remained tight during the recovery, despite rising aggregate consumption.