The Volatility Trap: Precautionary Saving, Investment, and Aggregate Risk

Author/Editor:

Reda Cherif ; Fuad Hasanov

Publication Date:

May 1, 2012

Electronic Access:

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Summary:

We study the effects of permanent and temporary income shocks on precautionary saving and investment in a "store-or-sow" model of growth. High volatility of permanent shocks results in high precautionary saving in the safe asset and low investment, or a "volatility trap." Namely, big savers invest relatively little. In contrast, low volatility of permanent shocks leads to low precautionary saving and high or low investment, depending on the volatility of temporary shocks. Empirical evidence shows a nonlinear relationship between investment and saving and that investment is a hump-shaped function of the volatility of permanent shocks, as predicted by the model.

Series:

Working Paper No. 2012/134

Subject:

Agricultural commodities Balance of payments Commodities Current account surpluses Income Income shocks National accounts Precautionary savings

English

Publication Date:

May 1, 2012

ISBN/ISSN:

9781475503869/1018-5941

Stock No:

WPIEA2012134

Pages:

21

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