Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 591: Aggregate Savings When Individual Income Varies

Martin Floden ()
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Martin Floden: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: This paper examines aggregate savings in a general equilibrium model where infinitely lived households face volatile (and possibly uncertain) income paths, hold a risk-free asset, and face a liquidity constraint. I first show that the equilibrium capital stock in an economy without uncertainty, but where individual income varies, can be larger than in an economy where each household's income is constant. When income is stochastic, the equilibrium capital stock is always larger than when income is constant. This additional capital accumulation has sometimes been interpreted as precautionary savings, but I demonstrate that it is mostly generated by permanent-income motives.

Keywords: equilibrium interest rate; aggregate savings; precautionary saving; infinite horizon; general equilibrium

JEL-codes: D52; D91; E21

16 pages, March 23, 2005

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