Buffer-Stock Saving in a Krusell-Smith World
29 Pages Posted: 11 Feb 2014
Date Written: January 27, 2014
A large body of microeconomic evidence supports Friedman (1957)'s proposition that household income can be reasonably well described as having both transitory and permanent components. We show how to modify the widely-used macroeconomic model of Krusell and Smith (1998) to accommodate such a microeconomic income process. Our incorporation of substantial permanent income shocks helps our model to explain a substantial part of the large degree of empirical wealth heterogeneity that is unexplained in the baseline Krusell and Smith (1998) model, even without heterogeneity in preferences.
Keywords: microfoundations of macroeconomics, household income process, aggregate uncertainty, wealth inequality
JEL Classification: D12, D31, D91, E21
Suggested Citation: Suggested Citation