The Intergenerational Redistribution of Wealth and Welfare in Great Recessions

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

NSF Proposal 1123547: Draft Award Abstract "The Intergenerational Redistribution of Wealth and Welfare in Great Recessions" By Dirk Krueger The economic downturn that started in the second half of 2007 and continues today is the most severe recession since the great depression of the 1930?s. A recent large literature investigates the causes and aggregate consequences of this so-called great recession. This project in contrast studies how the wealth and economic welfare losses from this severe decline in aggregate economic activity are distributed across different age cohorts in the population. The focus on the age dimension is motivated by the empirical observation from household level data that labor earnings and net worth (the value of all assets net of all debts) display a distinct profile over the life cycle. Asset holdings are strongly concentrated among older households whereas younger households possess very little net worth, but can expect substantial future labor income. Since the price of assets such as stocks and houses declined by about three times as much as labor incomes in the great recession, the main hypothesis evaluated in this project is that the wealth and welfare losses from the recent economic crisis are very unevenly distributed across households of different ages, and are concentrated among the elderly. In order to quantitatively investigate this hypothesis this project develops a large scale overlapping generations (OLG) model with aggregate risk, an endogenous household labor-leisure and portfolio choice as well as government tax, debt and social security policies, and calibrates it to pre-crisis life cycle labor income and asset profiles observed in 2007 Survey of Consumer Finances (SCF) data. It then generates, within the model, a decline of aggregate economic activity of a magnitude observed between 2007 and 2009, and first analyzes whether the model can generate a fall in asset prices three times the size of output, as observed in the data. The project then uses the model to measure how the welfare losses from the great recession are distributed across different age cohorts, including future generations. Finally it employs the developed model to study how the fiscal policy response to the great recession (e.g. the direct and indirect purchase of assets by the government through the Troubled Asset Relief Program, TARP) has shaped the age distribution of welfare losses implied by the downturn, and how alternative strategies to finance the cost of these policies (tax financing versus debt financing) would impact this distribution. The intended broader impact resulting from the project is (at least) twofold. First, and most directly, the developed model, calibration and the numerical algorithm to solve the model will be made publically available, and thus can be applied by any researcher interested in studying the re-distributional consequences of other large economic shocks (such as demographic shocks or natural catastrophes on a national scale) across different generations. Second, the results derived from the analysis of the actual and counterfactual hypothetical fiscal policy responses to the great recession are not only informative about the desirability of these policies in the current economic downturn, but can also provide guidance to the research and public policy discussion about the redistributive consequences of future fundamental fiscal policy reforms (including social security and Medicare reforms) that might be enacted in response to large economic crises.