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Demand, wealth inequality and the business cycle

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  • Cavallari, Lilia
  • D’Addona, Stefano
  • Porchia, Paolo

Abstract

We consider a flexible price continuous-time DSGE model of a closed economy populated by heterogeneous households subject to uninsurable idiosyncratic income risk and aggregate TFP shocks. The economy produces a variety of imperfectly substitutable final goods. Our main innovation is a rich representation of household consumption and saving behavior allowing for a time-varying elasticity of substitution across varieties. Specifically, we consider a utility function displaying Increasing Elasticity of Substitution (IES). We provide a convenient approach to handle the complex dynamic programming problem implied by income heterogeneity, aggregate shocks and non-homothetic preferences. We show that IES preferences help to replicate important features of the wealth distribution observed in the data together with a plausible macroeconomic dynamics.

Suggested Citation

  • Cavallari, Lilia & D’Addona, Stefano & Porchia, Paolo, 2025. "Demand, wealth inequality and the business cycle," Journal of Macroeconomics, Elsevier, vol. 85(C).
    • Handle: RePEc:eee:jmacro:v:85:y:2025:i:c:s0164070425000308
    DOI: 10.1016/j.jmacro.2025.103693
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