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Inequality and Aggregate Demand

Author

Listed:
  • 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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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Inequality and Aggregate Demand
      by Christian Zimmermann in NEP-DGE blog on 2016-11-23 01:42:48

    Citations

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    Cited by:

    1. M. Marx & B. Mojon & F. Velde, 2017. "Why Have Interest Rates Fallen far Below the Return on Capital," Working papers 630, Banque de France.
    2. Andreas Fagereng & Martin B. Holm & Gisle J. Natvik, 2016. "MPC heterogeneity and household balance sheets," Discussion Papers 852, Statistics Norway, Research Department.
    3. Krueger, D. & Mitman, K. & Perri, F., 2016. "Macroeconomics and Household Heterogeneity," Handbook of Macroeconomics, Elsevier.
    4. Keshav Dogra & Sushant Acharya, 2017. "The Side Effects of Safe Asset Creation," 2017 Meeting Papers 1453, Society for Economic Dynamics.
    5. Balamatsias, Pavlos, 2018. "Democracy and government spending," MPRA Paper 84975, University Library of Munich, Germany.
    6. 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.
    7. repec:eee:chieco:v:46:y:2017:i:c:p:208-228 is not listed on IDEAS
    8. Galí, Jordi, 2018. "The State of New Keynesian Economics: A Partial Assessment," CEPR Discussion Papers 13095, C.E.P.R. Discussion Papers.
    9. Jordi Galí, 2018. "The State of New Keynesian Economics: A Partial Assessment," NBER Working Papers 24845, National Bureau of Economic Research, Inc.
    10. Pierre Monnin, 2017. "Monetary Policy, Macroprudential Regulation and Inequality," Discussion Notes 1702, Council on Economic Policies.
    11. repec:aea:jecper:v:32:y:2018:i:3:p:87-112 is not listed on IDEAS
    12. Atanas Pekanov, 2018. "The New View on Fiscal Policy and its Implications for the European Monetary Union," WIFO Working Papers 562, WIFO.

    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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