Showing papers on "Precautionary savings published in 2011"

Financially Fragile Households: Evidence and Implications

Abstract: We examine households’ financial fragility by looking at their capacity to come up with $2,000 in 30 days. Using data from the 2009 TNS Global Economic Crisis Study, we document that approximately one-quarter of U.S. respondents are certain they could not come up with that sum. If we include respondents who report being probably unable to do so, nearly half of respondents are financially fragile. Although financial fragility is more severe among low-income households, a sizable fraction of seemingly middle-class Americans are also at risk. Respondents with low educational attainment and no financial education, families with children, those who have suffered large wealth losses, and the unemployed are also more likely than others to report being unable to cope with a financial shock. Households’ own savings are the resource used most often to deal with shocks, but resources of family and friends, formal and alternative credit, increased work hours, and sale of possessions are also used frequently, especially among some subgroups. These results indicate the need to look beyond precautionary savings to understand how families cope. We also find evidence suggestive of a “pecking order” of coping methods, with savings first in line. Comparing financial fragility and methods of coping among the United States and seven other industrialized countries, we find differences in coping ability but also general evidence of a consistent ordering of methods.

Credit Crises, Precautionary Savings, and the Liquidity Trap

Abstract: We study the effects of a credit crunch on consumer spending in a heterogeneous-agent incomplete-market model. After an unexpected permanent tightening in consumers' borrowing capacity, some consumers are forced to deleverage and others increase their precautionary savings. This depresses interest rates, especially in the short run, and generates an output drop, even with flexible prices. The output drop is larger with nominal rigidities, if the zero lower bound prevents the interest rate from adjusting downwards. Adding durable goods to the model, households take larger debt positions and the output response may be larger.

The Composition and Drawdown of Wealth in Retirement

Abstract: As the “baby boomers” approach and enter their retirement years, the accumulation phase of their life-cycle is nearly over. Thus, the focus of many researchers, financial services firms, and public policymakers concerned with retirement saving is shifting from the accumulation of resources while working to the drawdown of resources during retirement. Retired households are dependent on the annuitized income streams that they have built up during their working careers and on the wealth that they have accumulated in other forms. The two most common annuitized income streams are Social Security benefits and the payments from defined benefit pension plans. These payout streams provide income for life—and thus provide some protection against falling into poverty if one lives an especially long life. The three most common sources of accumulated wealth are equity in an owner-occupied home, financial assets such as bonds and stocks, and financial assets held in a personal retirement account such as an Individual Retirement Arrangement or a 401(k) plan. Throughout our analysis, we will define “retirement-age households” as those headed by someone between the ages of 65 and 69. In 2008, just over 80 percent of these households had some equity in their home or another property, while 52 percent had assets in personal retirement accounts. A much higher fraction—87 percent—had some financial assets outside their retirement accounts, but for many households the amount of such assets was relatively modest. Only 45 percent had more than $20,000 in non-retirement-account financial assets. The median financial asset holding for this group, including holdings in personal retirement accounts, is $52,000. In short, many households have small enough amounts of accumulated wealth that they will depend heavily on the life-contingent payout streams offered by Social Security and, if they have one, a defined benefit pension. This paper presents evidence on the resources available to households as they enter retirement. It draws heavily on data collected by the Health and Retirement Study, which we sometimes refer to as the “HRS.” We calculate the “potential additional annuity income” that households could purchase, given their holdings of non-annuitized financial assets at the start of retirement. Even if households used all of their financial assets inside and outside personal retirement accounts to purchase a life annuity, only 47 percent of households between the ages of 65 and 69 in 2008 could increase their life-contingent income by more than $5,000 per year. At the upper end of the wealth distribution, however, a substantial number of households could make large annuity purchases. We also consider the role of housing equity in the portfolios of retirement-age households and explore the extent to which households draw down housing equity and financial assets as they age. We find that many households appear to treat housing equity and non-annuitized financial assets as “precautionary savings,” tending to draw them down only when they experience a shock such as the death of a spouse or a period of substantial medical outlays. Because home equity is often conserved until very late in life, for many households it may provide some insurance against the risk of living longer than expected. A brief conclusion summarizes our findings and indicates how they bear on a number of policy issues, such as the role for annuity defaults in retirement saving plans.

Households' Savings in China

Abstract: This paper studies the determinants of Chinese households’ saving. Domestic saving in China is the highest in the world in terms of GDP and it is mirrored in a large and persistent current account surplus. First, we show that notwithstanding the rising contribution of government and firms to national savings, they stand out because of households’ behaviour. Our econometric analysis proceeds from the work of Modigliani and Cao (2004) that explained rising personal saving in China within the life-cycle hypothesis. We prove that their explanation is insufficient. Then, using panel data and exploiting differences among provinces and between urban and rural households, we show that there is a significant dissimilarity in savings decisions in urban and rural areas and that motives other than those envisaged in the life-cycle model might play a major role, above all precautionary savings and liquidity constraints. Our results suggest that to reduce the propensity to save of Chinese households it is necessary to improve the provision of social services and to facilitate access to credit.

Correlated risks, bivariate utility and optimal choices

Abstract: In this paper, we consider a decision-maker facing a financial risk flanked by a non-financial background risk such as health or environmental risk. A decision has to be made about the amount of an investment (in the financial dimension) resulting in a future benefit either in the same dimension (savings) or in the other dimension (environmental quality or health improvement. In this framework, we study the impact of the correlation between the two risks on optimal choices. In the saving problem, we find conditions ensuring that positive correlation between the two risks implies that the optimal amount of savings increases. These conditions involve specific requirements on the direct and cross derivatives of the two-argument utility function. Similarly, we find a different and specific set of conditions ensuring that the same conclusion on optimal investment for health (environmental) improvement is reached. The two sets of conditions determined support the conclusion that the signs of the derivatives of the two-argument utility function should alternate.

Shocks and Asset Dynamics in Ethiopia

Abstract: This article uses household survey panel data of 416 rural households to study asset dynamics in the northern highlands of Ethiopia and the response of assets to shocks. The period under examination (1996–2003) was marked by severe environmental shocks, including a series of droughts. The article empirically studies the nature of household asset paths over time, using as the point of departure the theory on precautionary savings behavior. Results indicate that the response of assets to weather shocks, the differential effect of these shocks on liquid and less liquid forms of wealth holdings, and the nature of asset dynamics are all consistent with the implications of a precautionary motive for holding wealth.

The Consumption Response to Seasonal Income: Evidence from Japanese Public Pension Benefits †

Abstract: Japanese public pension benefits, which were distributed quarterly through February 1990, and every other month since then, induce substantial but predictable income fluctuations. The relative magnitude of the payments combined with the delay between payments yields a stronger test of the Life-Cycle/Permanent Income Hypothesis than in prior studies. Applying two identification strategies to monthly household panel data, we find that consumption significantly responds to quarterly benefit receipt. Additional analysis suggests that our findings cannot be explained by either liquidity constraints or precautionary savings motives. (JEL D12, D91, E21, H55)

Credit Crises, Precautionary Savings and the Liquidity Trap

Abstract: We study the effects of a credit crunch on consumer spending in a heterogeneous-agent incomplete-market model. After an unexpected permanent tightening in consumers' borrowing capacity, some consumers are forced to deleverage and others increase their precautionary savings. This depresses interest rates, especially in the short run, and generates an output drop, even with flexible prices. The output drop is larger with nominal rigidities, if the zero lower bound prevents the interest rate from adjusting downwards. Adding durable goods to the model, households take larger debt positions and the output response may be larger.

When Does Uncovered Interest Parity Hold

Abstract: A consensus is emerging that returns to the currency carry trade are driven by two factors. One of these is clearly consumption risk but there is disagreement about the identity of the remaining factor. This paper bolsters the case for volatility being the unknown factor. A structural model that specifies that monetary volatility is the second factor is tested for 42 monetary regimes using the artificial economy methodology. The negative slope in the Fama regression arises when monetary volatility is low and the precautionary savings motive dominates the intertemporal substitution motive. When monetary volatility is high, the Fama slope is positive in line with uncovered interest parity. We conclude that, given the predominance of precautionary savings, the degree of monetary volatility explains whether uncovered interest parity holds.

On-the-Job Search and Precautionary Savings: Theory and Empirics of Earnings and Wealth Inequality

Abstract: In this paper, I develop and estimate a model of the labor market that can account for both the inequality in earnings and the much larger inequality in wealth observed in the data. I show that an equilibrium model of on-the-job search, augmented to account for saving decisions of workers, provides a direct and intuitive link between the empirical earnings and wealth distributions. The mechanism that generates the high degree of wealth inequality in the model is the dynamic of the “wage ladder” resulting from the search process. There is an important asymmetry between the incremental wage increases generated by on-the-job search (climbing the ladder) and the drop in income associated with job loss (falling off the ladder). The behavior of workers in low paying jobs is primarily governed by the expectation of wage growth, while the behavior of workers near the top of the distribution is driven by the possibility of job loss. This feature of the model generates differential savings behavior at different points in the earnings distribution. The wage growth expected by low wage workers, combined with the fact that their earnings are not much higher than unemployment benefits, causes them to dis-save. As a worker’s wage increases, the incentive to save increases: the potential for wage growth declines and it becomes increasingly important to insure against the large income reduction associated with job loss. The fact that high wage and low wage workers have such different savings behavior generates an equilibrium wealth distribution that is much more unequal than the equilibrium wage distribution. I estimate the structural parameters of the model by simulation-based methods using the 1979 youth cohort of the NLSY. The estimates indicate that the micro-level search and savings behavior—estimated from the dynamics of individuals’ labor market histories and wealth accumulation decisions—aggregates to replicate the cross-sectional inequality in earnings and wealth for this cohort.

Income Shocks and Household Risk-Coping Strategies: Evidence from Rural Vietnam

Abstract: This paper considers the various strategies rural households employ to avoid consumption shortfalls caused by realizations of adverse income shocks. First, we develop an ex post theoretical model within an inter-temporal utility maximizing framework which we use to explain households’ decisions to insure against idiosyncratic risk and save to protect against uninsurable spatially covariant risk. In the theoretical model we show that the latter can take a variety of different asset forms depending on the absolute level of risk aversion of the household and the variability in asset returns. Second, using household level panel data from Vietnam we test the extent to which households’ smooth consumption over time and how this depends on the presence of insurance and saving instruments. Third, we consider savings and liquid asset holdings as a form of self-insurance or precautionary savings against spatially covariant shocks. Overall, our results suggest that households deplete their stock of total liquid assets in the event of exposure to both exogenous and idiosyncratic income shocks. The ability of households to cope is also dependent on their receipt of public and private transfers in the event of an exogenous natural shock with insurance claims serving to alleviate the depletion of livestock holdings in the event of insurable idiosyncratic income shocks. These results are particularly pronounced for low and middle wealth groups.

Financially Fragile Households: Evidence and Implications [with Comments and Discussion]

Abstract: We examine households' financial fragility by looking at their capacity to come up with $2,000 in 30 days. Using data from the 2009 TNS Global Economic Crisis Study, we document that approximately one-quarter of U.S. respondents are certain they could not come up with that sum. If we include respondents who report being probably unable to do so, nearly half of respondents are financially fragile. Although financial fragility is more severe among low-income households, a sizable fraction of seemingly middle-class Americans are also at risk. Respondents with low educational attainment and no financial education, families with children, those who have suffered large wealth losses, and the unemployed are also more likely than others to report being unable to cope with a financial shock. Households' own savings are the resource used most often to deal with shocks, but resources of family and friends, formal and alternative credit, increased work hours, and sale of possessions are also used frequently, especially among some subgroups. These results indicate the need to look beyond precautionary savings to understand how families cope. We also find evidence suggestive of a "pecking order" of coping methods, with savings first in line. Comparing financial fragility and methods of coping among the United States and seven other industrialized countries, we find differences in coping ability but also general evidence of a consistent ordering of methods.

Incomplete markets and the output–inflation tradeoff

Abstract: This paper analyses the effects of money shocks on macroeconomic aggregates in a tractable flexible-price, incomplete-markets environment that generates persistent wealth inequalities amongst agents. In this framework, current inflation redistribute wealth from the cash-rich employed to the cash-poor unemployed and induce the former to increase their labour supply in order to maintain their desired levels of consumption and precautionary savings. If the shocks are persistent, however, they also raise inflation expectations and thus deter the employed from saving and supplying labour. We relate the strength of these two inflation taxes to the underlying parameters of the model and study how they compete in determining the overall sign and slope of the implied ‘output–inflation tradeoff’ relation.

Experiments on Intertemporal Consumption with Habit Formation and Social Learning

Abstract: The standard approach to modeling intertemporal consumption is to assume that consumers are solving a dynamic optimization problem. Under realistic descriptions of utility and uncertainty—stochastic income and habit formation-- these intertemporal problems are very difficult to solve. Optimizing agents must build up precautionary savings to buffer bad income realizations, and must anticipate the negative “internality” of current consumption on future utility, through habits. Yet recent empirical evidence has shown that consumption behavior of the average household in society conforms fairly well to the prescriptions of the optimal solution. This paper establishes potential ways in which consumers can attain near-optimal consumption behavior despite their mathematical and computational limitations in solving the complicated optimization problem. Individual and social learning mechanisms are proposed to be one possible link. Using an experimental approach, results show that by incorporating social learning and individual learning into the intertemporal consumption framework, participants’ actual spending behavior converged effectively towards optimal consumption. While consumers persistently spend too much in early periods, they learn rapidly from their own experience (and “socially learn” from experience of others) to consume amounts close to optimal levels. Their spending is much more closely linked to optimal consumption (conditional on earlier spending) than to rule-of-thumb spending of current income or cash-on-hand. Despite their approximate optimality, consumers exhibit dramatic “loss-aversion” by strongly avoiding consumption levels which create negative levels of period-by-period utility (even when optimal utility is negative). The relative ratio of actual utilities to optimal utilities, for positive utility compared to negative, is 2.63. This coefficient is remarkably close to the coefficient of loss-aversion documented in a wide variety of risky and riskless choice domains, which shows that even when consumption is nearly-optimal, behavioral influences sharply affect decisions.

Towards a micro-founded theory of aggregate labor supply

Abstract: We build a heterogeneous life-cycle model which captures a large number of salient features of individual labor supply, by education, over the life cycle. The model provides an aggregation theory of individual labor supply, firmly grounded on micro evidence, and is used to study the aggregate labor supply responses to changes in the economic environment. We find that the aggregate labor supply elasticity to a transitory wage shock is 1.27, with the extensive margin accounting for 54% of the response. Furthermore, we also simulate the 1987 tax holiday in Iceland - a quasi-natural experiment - and find that the aggregate labor supply responses in the model are similar to those actually observed in Iceland.

Financially Fragile Households: Evidence and Implications

Abstract: This paper examines households' financial fragility by looking at their capacity to come up with $2,000 in 30 days. Using data from the 2009 TNS Global Economic Crisis survey, we document widespread financial weakness in the United States: Approximately one quarter of Americans report that they would certainly not be able to come up with such funds, and an additional 19% would do so by relying at least in part on pawning or selling possessions or taking payday loans. If we consider the respondents who report being certain or probably not able to cope with an ordinary financial shock of this size, we find that nearly half of Americans are financially fragile. While financial fragility is more severe among those with low educational attainment and no financial education, families with children, those who suffered large wealth losses, and those who are unemployed, a sizable fraction of seemingly "middle class" Americans also judge themselves to be financially fragile. We examine the coping methods people use to deal with shocks. While savings is used most often, relying on family and friends, using formal and alternative credit, increasing work hours, and selling items are also used frequently to deal with emergencies, especially for some subgroups. Household finance researchers must look beyond precautionary savings to understand how families cope with risk. We also find evidence of a "pecking order" of coping methods in which savings appears to be first in the ordering. Finally, the paper compares the levels of financial fragility and methods of coping among eight industrialized countries. While there are differences in coping ability across countries, there is general evidence of a consistent ordering of coping methods

Family dissolution and precautionary savings: an empirical analysis

Abstract: The main research question of this paper is whether or not the risk of family disruption has an impact on the consumption/saving decisions of households. Although little empirical work exists in this area, often presenting indirect evidence, the theory is divided over the effect of family risk over saving and wealth accumulation. By using data from the Italian Survey on Households Income and Wealth, we build a probabilistic model to assess the probability of marital splitting, and then we insert this probability as a distinct or interacted regressor, in a statistically consistent way, into a linear model of consumption. Furthermore, we study the differential behaviour, in terms of consumption/saving choices, of couples experiencing marital splitting over the subsequent two years. The main result of our analysis is that family disruption risk generates precautionary savings, reducing current consumption. In fact, according to our estimates, on average, the risk of divorce generates an amount of additional yearly precautionary savings of around 800 euros at constant prices of the year 2000, which represents 11% of overall household savings.

Making Sense of China's Excessive Foreign Reserves

Abstract: Large uninsured risk, severe borrowing constraints, and rapid income growth can create ex- cessively high household saving rates and large current account surpluses for emerging economies. Therefore, the massive foreign-reserve buildups by China are not necessarily the intended out- come of any government policies or an undervalued home currency, but instead a natural conse- quence of the country's rapid economic growth in conjunction with an ine¢ cient …nancial system (or lack of timely …nancial reform). A tractable growth model of precautionary saving is pro- vided to quantitatively explain China's extraordinary path of trade surplus and foreign-reserve accumulation in recent decades. Ironically, the analysis suggests that without a well-developed domestic …nancial market, the value of the renminbi (RMB) may signi…cantly depreciate, instead of appreciate, once the Chinese government abandons the linked exchange rate and the mas- sive amount of precautionary savings of Chinese households are unleashed toward international …nancial markets to search for better returns.

Targeting the Poor: A Macroeconomic Analysis of Cash Transfer Programs

Abstract: This paper introduces cash transfers targeting the poor in an incomplete markets model with heterogeneous agents facing idiosyncratic risk. These transfers change the degree of insurance in the economy and affect precautionary motives asymmetrically, leading the poorest households to decrease savings proportionally more than their richer counterparts. In a model economy calibrated to Brazil, once the cash transfer program is adopted, wealth inequality and social welfare increase, poverty decreases, while employment and income inequality remain about the same. Imperfect access to financial markets is important for these results, whereas whether the program is funded with lump sum or distortive taxes is not.

The Composition and Draw-Down of Wealth in Retirement

Abstract: This paper presents evidence on the resources available to households as they enter retirement. It draws heavily on data collected by the Health and Retirement Study and calculates the "potential additional annuity income" that households could purchase, given their holdings of non-annuitized financial assets at the start of retirement. Even if households used all of their financial assets inside and outside personal retirement accounts to purchase a life annuity, only 47 percent of households between the ages of 65 and 69 in 2008 could increase their life-contingent income by more than $5,000 per year. At the upper end of the wealth distribution, however, a substantial number of households could make large annuity purchases. The paper also considers the role of housing equity in the portfolios of retirement-age households, and explores the extent to which households draw down housing equity and financial assets as they age. Many households appear to treat housing equity and non-annuitized financial assets as "precautionary savings," tending to draw them down only when they experience a shock such as the death of a spouse or a period of substantial medical outlays. Because home equity is often conserved until very late in life, for many households it may provide some insurance against the risk of living longer than expected.

Corporate Precautionary Savings: Evidence from the Recent Financial Crisis

Abstract: This paper examines the effects of the recent financial crisis on corporate cash holdings and saving propensities. We find that on average, firms reduce their cash holdings in the first year of the crisis when the supply of external finance is tightened, and increase their holdings in cash from the third quarter of 2008 when the demand-side effects of the crisis are stronger. More importantly, we find that the positive cash flow sensitivities of cash are significantly stronger during the financial crisis. This effect is more pronounced in financially constrained firms and firms with a high precautionary motive. Our results suggest that firms tended to save more as a precautionary motive during the recent financial crisis.

Can the Precautionary Motive Explain the Chinese Corporate Savings Puzzle? Evidence from the Liquid Assets Perspective

Abstract: This paper uses matched customs and firm-level data from Q1 2002 to Q4 2009 to examine which factors influence corporate savings decisions in China. The investigation shows that the precautionary motive plays a crucial role in explaining firms’ savings behavior. I start by showing that a firm’s savings are highly sensitive to its ownership structure. Private firms tend to save more than state-owned enterprise (SOE) when firms with valuable future investment opportunities and limited access to finance might accumulate precautionary savings. To address endogeneity concerns, difference-in-difference estimations support the causal impact of precautionary motives on corporate savings. Strikingly, I find that export firms tended to save more during the recent crisis. This finding challenges the mainstream view that an unexpected negative shock to external demand for the export-oriented industry would cause its savings to drop significantly. One interpretation of the results is that the precautionary motive under financial friction increases corporate propensity to save. The results highlight the importance of developing Chinese financial markets in order to channel savings into investment. One policy implication is that the low dividend payment by SOEs is less important in causing the gap between saving and investment than previous studies have suggested.

The Effects of Wage Volatility on Growth

Abstract: This paper develops a theoretical model that identifies the relationship between the volatility of private sector wages and growth. The model suggests two distinct channels in which wage volatility affects growth: a positive direct way and a negative indirect way. The direct effect stems from precautionary savings, whereas the indirect effect works through the mediating role of government size. Our empirical part of applying a 3SLS approach to a panel of 20 high-income OECD countries provides strong evidence for the existence of both effects. Various robustness tests confirm the results. In addition, our data shows that the indirect effect is stronger in smaller countries with a population under 10 million people, whereas the direct effect is more significant in bigger countries.

of health and employment risks on precautionary savings

Abstract: This paper extends the idea of using ex-ante risk measures in a model of precautionary savings by explicitly simulating future net-income risks. The uncertainty measure takes into account the interdependency of labour market and health status. The model is estimated for prime age males using the German Socio-Economic Panel Study for years 2001-2007. The empirical analysis is conducted using a measure for savings stocks and savings flows. The latter model allows to control for individual specific eects. I find evidence for precautionary savings in response to the uncertainty measures. The results are robust and stable across specifications. There is evidence for a share of precautionary wealth of about 14 to 17 percent.

Precautionary Savings and Global Imbalances in World General Equilibrium

Abstract: In this paper we assess the implications of precautionary savings for global imbalances by considering a world economy model composed by the US, the Euro Area, Japan, China, oil-exporting countries, and the rest of the world. These areas are assumed to differ only with respect to GDP volatility which is calibrated based on the 1980-2008 period. The model predicts a wide dispersion in net foreign asset positions, with the highly volatile oil-exporting countries accumulating very large asset holdings. While heterogeneity in GDP volatility may lead to large imbalances in international investment positions, its impact on current accounts is much weaker. This is because countries are expected to move towards their optimal NFA at a very slow pace.

Households' savings in China

Abstract: This paper studies the determinants of Chinese householdsi?½ saving. Domestic saving in China is the highest in the world in terms of GDP and it is mirrored in a large and persistent current account surplus. First, we show that notwithstanding the rising contribution of government and firms to national savings, they stand out because of householdsi?½ behaviour. Our econometric analysis proceeds from the work of Modigliani and Cao (2004) that explained rising personal saving in China within the life-cycle hypothesis. We prove that their explanation is insufficient. Then, using panel data and exploiting differences among provinces and between urban and rural households, we show that there is a significant dissimilarity in savings decisions in urban and rural areas and that motives other than those envisaged in the life-cycle model might play a major role, above all precautionary savings and liquidity constraints. Our results suggest that to reduce the propensity to save of Chinese households it is necessary to improve the provision of social services and to facilitate access to credit.

Making Sense of Chinas Excessive Foreign Reserves

Abstract: Large uninsured risk, severe borrowing constraints, and rapid income growth can imply excessively high household saving rates Therefore, the global saving glut and massive foreign reserves accumulated by emerging economies are not necessarily the intended outcome of any government policies or undervalued home currency, but instead a natural consequence of the ine¢ cient …nancial system (or lack of timely …nancial reform) in these countries Since …nancial development is a much more complicated task and harder goal to achieve than GDP growth, even if the Chinese government appreciate RMB dramatically, trade imbalances between China and the United States will remain, as was the case between Japan and the US in the last century Worse still, without a well developed domestic …nancial market, the RMB may signi…cantly depreciate, instead of appreciate, once the government in China abandons the linked exchange rate and the massive amount of precautionary savings of Chinese households unleashed toward the world …nancial markets in seeking for better returns In other words, the gigantic asset demand caused by precautionary savings may completely dominate the Balassa-Samuelson e¤ect on the exchange rate Keywords: Exchange Rate Determination, Borrowing Constraints, Bu¤er Stock Saving, Global Imbalance, Foreign Reserves, Trade De…cit, Incomplete Markets, Uninsured Risk