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Inequality and Aggregate Demand

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  • Matthew Rognlie

    (Massachusetts Institute of Technology)

  • Adrien Auclert

    (Princeton)

Abstract

We explore the quantitative effects of transitory and persistent increases in income inequality on equilibrium interest rates and output. Our starting point is a Bewley-Huggett-Aiyagari model featuring rich heterogeneity and earnings dynamics as well as downward nominal wage rigidities. A temporary rise in inequality, if not accommodated by monetary policy, has an immediate effect on output that can be quantified using the empirical covariance between income and marginal propensities to consume. A permanent rise in inequality can lead to a permanent Keynesian recession, which is not fully offset by monetary policy due to a lower bound on interest rates. We show that the magnitude of the real interest rate fall and the severity of the steady-state slump can be approximated by simple formulas involving quantifiable elasticities and shares, together with two parameters that summarize the effect of idiosyncratic uncertainty and real interest rates on aggregate savings. For plausible parametrizations the rise in inequality can push the economy into a liquidity trap and create a deep recession. Capital investment and deficit-financed fiscal policy mitigate the fall in real interest rates and the severity of the slump.

Suggested Citation

  • Matthew Rognlie & Adrien Auclert, 2016. "Inequality and Aggregate Demand," 2016 Meeting Papers 1353, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:1353
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    1. Inequality and Aggregate Demand
      by Christian Zimmermann in NEP-DGE blog on 2016-11-23 01:42:48

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    Cited by:

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    3. Keshav Dogra & Sushant Acharya, 2017. "The Side Effects of Safe Asset Creation," 2017 Meeting Papers 1453, Society for Economic Dynamics.
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    5. M. Marx & B. Mojon & F. Velde, 2017. "Why Have Interest Rates Fallen far Below the Return on Capital," Working papers 630, Banque de France.
    6. Jonathan Heathcote & Fabrizio Perri, 2018. "Wealth and Volatility," Review of Economic Studies, Oxford University Press, vol. 85(4), pages 2173-2213.
    7. Atanas Pekanov, 2018. "The New View on Fiscal Policy and its Implications for the European Monetary Union," WIFO Working Papers 562, WIFO.
    8. Jesús Fernández-Villaverde & Samuel Hurtado & Galo Nuño, 2019. "Financial Frictions and the Wealth Distribution," NBER Working Papers 26302, National Bureau of Economic Research, Inc.
    9. Andreas Fagereng & Martin B. Holm & Gisle J. Natvik, 2016. "MPC heterogeneity and household balance sheets," Discussion Papers 852, Statistics Norway, Research Department.
    10. Bilbiie, Florin Ovidiu & Känzig, Diego R & Surico, Paolo, 2019. "Capital, Income Inequality, and Consumption: the Missing Link," CEPR Discussion Papers 14118, C.E.P.R. Discussion Papers.
    11. Krueger, D. & Mitman, K. & Perri, F., 2016. "Macroeconomics and Household Heterogeneity," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 843-921, Elsevier.
    12. Glick, Reuven, 2020. "r* and the global economy," Journal of International Money and Finance, Elsevier, vol. 102(C).
    13. Zhao, Da & Wu, Tianhao & He, Qiwei, 2017. "Consumption inequality and its evolution in urban China," China Economic Review, Elsevier, vol. 46(C), pages 208-228.
    14. Slacalek, Jiri & Tristani, Oreste & Violante, Giovanni L., 2020. "Household balance sheet channels of monetary policy: A back of the envelope calculation for the euro area," Journal of Economic Dynamics and Control, Elsevier, vol. 115(C).
    15. Marco Del Negro & Domenico Giannone & Marc P. Giannoni & Andrea Tambalotti, 2017. "Safety, Liquidity, and the Natural Rate of Interest," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 48(1 (Spring), pages 235-316.
    16. Edouard Challe, 2017. "Uninsured Unemployment Risk and Optimal Monetary Policy," Working Papers 2017-54, Center for Research in Economics and Statistics.
    17. Pablo Cuba-Borda & Sanjay R. Singh, 2019. "Understanding Persistent Stagnation," International Finance Discussion Papers 1243, Board of Governors of the Federal Reserve System (U.S.).
    18. Jordi Galí, 2018. "The State of New Keynesian Economics: A Partial Assessment," Journal of Economic Perspectives, American Economic Association, vol. 32(3), pages 87-112, Summer.
    19. Yves Achdou & Jiequn Han & Jean-Michel Lasry & Pierre-Louis Lions & Benjamin Moll, 2017. "Income and Wealth Distribution in Macroeconomics: A Continuous-Time Approach," NBER Working Papers 23732, National Bureau of Economic Research, Inc.
    20. Balamatsias, Pavlos, 2018. "Democracy and government spending," MPRA Paper 84975, University Library of Munich, Germany.
    21. Pierre Monnin, 2017. "Monetary Policy, Macroprudential Regulation and Inequality," Discussion Notes 1702, Council on Economic Policies.
    22. Bilbiie, Florin O., 2020. "The New Keynesian cross," Journal of Monetary Economics, Elsevier, vol. 114(C), pages 90-108.

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    More about this item

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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