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Income Inequality, Financial Crises, and Monetary Policy

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Listed:
  • Isabel Cairo
  • Jae W. Sim

Abstract

We construct a general equilibrium model in which income inequality results in insufficient aggregate demand, deflation pressure, and excessive credit growth by allocating income to agents featuring low marginal propensity to consume, and if excessive, can lead to an endogenous financial crisis. This economy generates distributions for equilibrium prices and quantities that are highly skewed to the downside due to financial crises and the liquidity trap. Consequently, symmetric monetary policy rules designed to minimize fluctuations around fixed means become inefficient. A simultaneous reduction in inflation volatility and mean unemployment rate is feasible when an asymmetric policy rule is adopted.

Suggested Citation

  • Isabel Cairo & Jae W. Sim, 2018. "Income Inequality, Financial Crises, and Monetary Policy," Finance and Economics Discussion Series 2018-048, Board of Governors of the Federal Reserve System (US).
  • Handle: RePEc:fip:fedgfe:2018-48
    DOI: 10.17016/FEDS.2018.048
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    File URL: https://www.federalreserve.gov/econres/feds/files/2018048pap.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Monetary policy ; Credit ; Financial crises ; Income inequality;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G01 - Financial Economics - - General - - - Financial Crises

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