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When does heterogeneity matter?

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  • Yi Wen
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Abstract

How do movements in the distribution of income affect the macroeconomy? Krusell and Smith (1998) analyzed this question in a neoclassical growth model, and their results show that the representative-agent assumption provides a good approximation for aggregate behaviors of heterogeneous agents. This paper extends their analysis to a cash-in-advance model with heterogeneous money demand. It is shown that movements in the distribution of monetary income can have significant impact on the macroeconomy. For example, the dynamic responses of aggregate output to monetary shocks behave very differently from those of a representative agent; the welfare costs of moderate inflation are much higher than previously thought, up to 20% of consumption when the inequality of cash distribution is sufficiently large. This is in sharp contrast to the findings of Cooley and Hansen (1989) and Lucas (2000) based on representative-agent models.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2009-024.

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Date of creation: 2009
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Handle: RePEc:fip:fedlwp:2009-024

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Keywords: Liquidity (Economics) ; Money theory;

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  1. Fabio Clementi & Mauro Gallegati, 2005. "Pareto's Law of Income Distribution: Evidence for Grermany, the United Kingdom, and the United States," Microeconomics 0505006, EconWPA.
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  4. Orazio Attanasio & Luigi Guiso & Tullio Jappelli, 1998. "The Demand for Money, Financial Innovation, and the Welfare Cost of Inflation: An Analysis with Households' Data," CSEF Working Papers 03, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  5. Thomas F. Cooley & Gary D. Hansen, 1987. "The Inflation Tax in a Real Business Cycle Model," UCLA Economics Working Papers 496, UCLA Department of Economics.
  6. Robert J. Hodrick & Narayana Kocherlakota & Deborah Lucas, 1989. "The Variability of Velocity in Cash-In-Advance Models," NBER Working Papers 2891, National Bureau of Economic Research, Inc.
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Cited by:
  1. Salas, Sergio, 2013. "Credit frictions and unexpected credit crunches," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 161-181.

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