Abstract
I study the interactions between self-insurance and the long-term interest rate level. Households respond to more income risk by saving more for precautionary reasons. I show that this precautionary saving effect is stronger if the interest rate is lower and the income process is persistent. The intuition is as follows: for infinitely lived households facing persistent income risk, the insurance provided by wealth is primarily the flow income from wealth. If the interest rate is low, households need to accumulate more wealth to get the same degree of insurance. I simulate a quantitative model and show that aggregate consumption responses to income risk changes are very sensitive to the interest rate level: A one percentage point reduction in the interest rate results in a more than four times as large consumption response to heightened income risk.
