Balance Sheet Liquidity, Consumption Smoothing, and the Business Cycle

Abstract

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.

Mauricio Torres Ferro

PhD Candidate in Economics

My research interests include macroeconomics with heterogeneous agents and monetary policy.