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Keynes Fund


Summary of Project Results

Data on Individual Behaviour

The focus of the project is on individual saving behaviour in the face of risk, and especially across recessions.

This behaviour is shown in Figure 1 below. The question is why do individuals save so much in recessions, or equivalently, why do individuals stop borrowing in recessions. This is a puzzle for standard models in macroeconomics which assume that individuals will smooth out consumption: if consumption is being smoothed, then when income falls, borrowing must rise to keep consumption flat.

There are various potential reasons for this lack of consumption smoothing:


Figure 1: Personal Savings Across Recessions


  1. Uncertainty increases in recessions and this makes individuals wary of borrowing, and demand for credit falls.

  2. Banks shut down the supply of credit and so individuals are unabe to borrow. This means that in recessions when incomes fall, individuals are unable to borrow to maintain their spending.

  3. Asset values fall in recessions: individuals save to restore their wealth holdings.

  4. Government borrowing increases in recessions and individuals realise their future tax liability has gone up, and so will save more against this.


The rise in uncertainty in recessions is shown in the figure below:

When we put this path of uncertainty into our simulations of behaviour (discussed below), we see savings ratios spike up when recessions hit, and then savings rates falling sharply at the end of the recession. This sharp fall happens because once the uncertainty is resolved, individuals are left with larger stocks of precautionary assets and have no need to keep accumulating against uncertainty. This effect is across all age groups.

The reason why the restriction of the supply of credit does not seem relevant is that the rise in saving in recessions is seen across people of all age groups (excluding the retired): borrowing is primarily by the young, we would not expect those age 40-60 to be borrowing and so we would not expect them to be affected by banks cutting access to credit. This is also confirmed in our numerical simulations.

These patterns are common to the UK and US. Both also experienced large rises in government deficits through recent recessions. On the other hand, in Italy there has been an equally large rise in the government deficit but no offsetting rise in private saving rates.


Figure 2: Idiosyncratic Uncertainty Across Recessions


Individual Responses to Aggregate Risk

The key issue addressed by this project is to understand how individuals respond to risk over the business cycle and how this response is affected by the particular economic environment, especially access to credit. The underlying issue we want to address is understanding what the appropriate response of the government is to particular recessions: should the government try to relax the supply of credit or should it try to simulate spending directly.

To address this, we have a numerical model of individual behaviour over their life-cycle. Individuals are subject to individual-specific shocks to their wages and to the return on their asset holdings. Alongside this, there is a risk of recessions which affect all individuals. We model recessions in four different ways:


  1. An aggregate shock to the level of income

  2. A shock to the level of income, and an increase in the risk that individuals face

  3. A shock to the level of income and a contraction of the supply of credit

  4. A shock to the level of income and an asset price crash


To illustrate the outputs of this model, Figure 3 compares the effects of recession that is just an income shock with one that is also an increase in uncertainty. The top right hand figure shows, for example, the clear spike in saving in recessions that we see in the data.


Figure 3: Comparing a Income Shock Recession with an Uncertainty Shock Recession


Research Output

Saving on a Rainy Day, Borrowing for a Rainy Day, Sule Alan, Thomas F. Crossley and Hamish W. Low, (2015).

Abstract: The aim of this paper is to understand what a recession means for individual consumers, and to model in a life-cycle framework how individuals respond to recessions. Our focus is on the sharp increase in savings rates that have been observed in the current and recent recessions. We show empirically that these saving spikes were short-lived and common to all working age groups. We then study life-cycle models in which recessions involve one or more of: (i) an aggregate permanent negative shock to individual income; (ii) an increase in the variance of idiosyncratic permanent shocks; (iii) a tightening of credit constraints; (iv) asset market crashes. In simulations and in the data we aggregate explicitly from individual behavior. We model credit tightening as a constraint on new borrowing and this generates an option value of borrowing in good times. We show that the rise in the aggregate savings ratio is driven by increases in uncertainty, rather than tighening of credit; temporary shocks to the supply of credit generate increases in saving only among younger agents.

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Job Loss, Credit Constraints, and Consumption Growth, Thomas F. Crossley and Hamish W. Low, (2014), The Review of Economics and Statistics, Vol 96(5), pp. 876–884

Abstract: We use direct evidence on credit constraints to study their importance for household consumption growth and for welfare. We distentangle the direct effect on consumption growth of a currently binding credit constraint from the indirect effect of a potentially binding credit constraint that generates consumption risk. Our data are focused on job losers. We find that less than 5% of job losers experience a binding credit constraint, but those who do experience significant welfare losses, and consumption growth is 24% higher than for the rest of the population. However, even among those who are unconstrained and are able to borrow if needed, consumption responds to transitory income.

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Prof. Hamish Low


Professor Hamish Low is the James Meade Professor of Economics at the University of Oxford and a Professorial Fellow at Nuffield College. He is also a Research Fellow at the Institute for Fiscal Studies. His research interests are in Life-cycle Behaviour under Uncertainty, Unemployment Benefit, Optimal Income Taxation under Uncertainty, Computational Methods.





Cambridge Working Papers in Economics (CWPE)



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