Working Paper

Inequality and Asset Prices during Sudden Stops

Abstract: This paper studies the cross-sectional dimension of Fisher’s debt-deflation mechanism that triggers Sudden Stop crises. Analyzing microdata from Mexico, we show that this dimension has macroeconomic implications that operate via opposing effects. We propose a small open economy, asset-pricing model with heterogeneous-agents and aggregate risk to measure the effects of inequality during crises. In contrast to a representative-agent model, heterogeneity generates persistent current account reversals with smaller drops in asset prices and larger drops in consumption driven by the leveraged households. Moreover, in a lower inequality calibration, we find that crises are less severe, as observed in the data.

Keywords: Inequality; Sudden Stops; Debt-deflation; Asset-pricing; Household leverage;

JEL Classification: D31; E21; E44; F32; F41; G01;

https://doi.org/10.17016/IFDP.2024.1388

Bibliographic Information

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

Part of Series: International Finance Discussion Papers

Publication Date: 2024-03-29

Number: 1388