Wealth Inequality, Labor Market Arrangements and the Secular Decline in the Real Interest Rate

We develop a dynamic macroeconomic model in which the secular decline in real interest rates arises endogenously from rising wealth inequality. Challenging the standard “safe asset shortage” hypothesis, the model shows how falling real rates can coexist with a stable safe asset ratio—closely matching U.S. empirical patterns. The mechanism combines limited financial market participation, which concentrates capital ownership among a shrinking class of stockholders, with egalitarian wage bargaining, which generates time-varying labor income shares under incomplete markets. As inequality increases, stockholders face higher financial and operating leverage, increasing their consumption volatility and precautionary demand for bonds. At the same time, greater wage instability raises workers’ demand for safe assets. The resulting surge in precautionary savings from both groups depresses real returns and creates the appearance of a safe asset shortage, despite an unchanged supply. This outcome reflects a pecuniary externality: agents fail to internalize the aggregate constraint on safe assets, especially over the business cycle. Our calibrated model reproduces key macro-financial patterns and offers new insights into the joint dynamics of wealth distribution, labor market arrangements, and asset pricing.