MACRO UNCERTAINTY, UNEMPLOYMENT RISK, AND CONSUMPTION DYNAMICS

Abstract

Households' income heterogeneity is important to explain consumption dynamics in response to aggregate macro uncertainty: an increase in uncertainty generates a consumption drop that is stronger for lower‐income households. At the same time, labor markets are strongly responsive to macro uncertainty. A heterogeneous‐agent New Keynesian model with search‐and‐matching frictions in the labor market can account for these empirical findings. The mechanism at play is a feedback loop between lower‐income households who, being subject to higher unemployment risk, contract consumption more in response to heightened uncertainty, and firms that post fewer vacancies following a drop in demand.