In this paper, I study the importance of uncertain expenses for households’ savings and the short-run response to monetary policy. Using data from the Consumer Expenditure Survey (CEX), I classify a group of uncertain expenditure items representing 14.5% of total expenses and document that these uncertain expenses drive 41.8% of the short-run consumption response to monetary policy shocks. I develop a heterogeneous-agent incomplete markets model with two assets, money and bonds, where households use the two assets to self-insure against income and expenditure uncertainty. A timing friction in the portfolio choice problem and frictions in the goods market lead households to hold extra liquidity relative to their total consumption level. I show that self-insurance motives against expenditure risk imply a novel direct channel for the transmission of monetary policy to consumption through households’ optimal portfolio rebalancing in response to changes in the policy rate. In addition, the model generates concentration in the distribution of money holdings consistent with the data, a feature hard to reconcile with traditional transaction motives for money demand.

This paper studies how asset market illiquidity affects risk-sharing among asset holders. It is typically assumed that lower asset re-salability constrains those agents who need to sell the asset to smooth negative income shocks. However, a fall in liquidity amounts to a negative supply shock in the asset market, which creates excess demand for private financial claims. The asset price, in turn, must rise to equilibrate supply and demand. This response would leave the budget constraint for sellers of the assets unaffected, with no effect on consumption. I build a model where assets are traded subject to search and matching frictions with two types of agents, large households and financial intermediaries. Members of a typical household receive an idiosyncratic endowment shock, those who receive a high endowment participate in the market as buyers of the asset. In contrast, those who receive a low endowment are sellers. The matching technology is owned by financial intermediaries, who process the buy-sell claims at some cost. The transaction price is determined as the solution to a bargaining problem between buyers and sellers. Matching efficiency in this market endogenously determines the degree of asset illiquidity. It is shown that the combination of lower liquidity, along with the pricing mechanism derived from the bargaining problem, tightens the budget constraint for the members that receive the low endowment, who are less able to finance consumption. Consequently, the consumption wedge between household members increases, deviating from perfect risk sharing.

This paper examines the effects of aggregate conditions on the ability of households, with different balance sheets, to smooth consumption in the presence of idiosyncratic income shocks. Evidence is provided, using data from the Consumer Expenditure Survey (CEX), that risk sharing over the business cycle is asymmetric across households with balance sheets that differ in the degree of liquidity. Households with both liquid and illiquid assets are insured over the business cycle. Those with primarily illiquid assets smooth consumption less in busts, while those with no assets smooth consumption less in booms. This evidence is complemented by computing higher-order moments of the distribution of consumption over the business cycle. Similar to Constantinides and Ghosh (2017), there is a countercyclical negative skewness and an acyclical variance. This suggests that the large countercyclical income shocks identified by Guvenen, Ozkan, and Song (2014) are also transmitted to household consumption. However, when looking at the different household groups, it is found that a procyclical negative skewness in the distribution for households with no assets exists. In contrast, it does not exist for households with assets. These findings bolster the notion that asymmetric business cycle exposure exists for households that differ in their balance sheet composition.

This chapter studies the trade-offs that can arise between inflation targeting and financial stability objectives. We use a simple framework to conduct macroeconomic policy analysis under three strategies (1) a benchmark case where monetary policy pursues traditional price stability objectives; (2) monetary policy leaning against the wind; and (3) a case of policy coordination between monetary and macroprudential instruments. We find that, under certain circumstances, having financial stability objectives as an additional macroeconomic policy increases the volatility of inflation. We identify cases in which the tradeoffs in terms of macroeconomic volatility between policy objectives create scope for improvement when monetary and macroprudential policies are coordinated. These improvements are generally larger when financial shocks are the main driver of macroeconomic fluctuations.