Working Paper

Income Inequality, Financial Crises, and Monetary Policy


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.

Keywords: Financial crises; Monetary policy; Credit; Income inequality;

JEL Classification: E44; E32; G01; E52;

https://doi.org/10.17016/FEDS.2018.048

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Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2018-07-19

Number: 2018-048

Pages: 58 pages