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Capital Risk, Fiscal Policy, and the Distribution of Wealth

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  • Andrea Modena
  • Luca Regis

Abstract

We develop a continuous-time model of a production economy where households face leverage constraints, uninsurable labour income shocks, and capital depreciation risk. We derive a numerical approximation of the model’s competitive equilibrium and compare it with a benchmark economy with no capital risk. Introducing capital risk generates a positive risk premium while fostering aggregate capital accumulation and safe asset demand. At the same time, it exacerbates wealth inequality by making poor households’ net worth more volatile than their wealthier peers. In this framework, we investigate the impact of fiscal policy on households’ wealth distribution and welfare. Fiscal policy influences the equilibrium wealth distribution by changing the risk premium. This channel unevenly impacts households’ consumption and asset allocation decisions, depending on their wage and net worth levels. Tax cuts on risky capital may benefit wealthy or poor households, depending on whether they are financed by raising taxes on safe assets or labour.

Suggested Citation

  • Andrea Modena & Luca Regis, 2023. "Capital Risk, Fiscal Policy, and the Distribution of Wealth," CRC TR 224 Discussion Paper Series crctr224_2023_454, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2023_454
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp454
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    More about this item

    Keywords

    fiscal policy; incomplete market; portfolio choices; wealth distribution;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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