Working Paper 2018-02: Adrien Auclert & Matthew Rognlie

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02192018-WP-inequality-aggregate-demand

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Authors:

Adrien Auclert, Assistant Professor of Economics, Stanford University
Matthew Rognlie, Assistant Professor of Economics, Northwestern University


Abstract:

We explore the transmission mechanism of income inequality to output. In the short run, higher inequality reduces output because marginal propensities to consume are negatively correlated with incomes, but this effect is quantitatively small in the data and in our model. In the long run, the output effects of income inequality are small if inequality is caused by rising dispersion in individual fixed effects, but can be large if it is the manifestation of higher individual income risk. We formalize the connection between partial and general equilibrium effects, and show that the two are closely related under standard assumptions about the behavior of monetary policy. Our economy features a depressed long-run real interest rate, allowing us to quantify the potential contribution of income inequality to secular stagnation.