The past 40 years have been characterized by a decrease in the rate of return on safe assets, an increase in the equity premium, an increase in the price of financial assets, and an increase in labor income and wealth inequality. Using a heterogeneous-agent model featuring permanent labor income inequality, a two-asset structure, and nonhomothetic preferences, we investigate the impact of an increase in permanent labor income inequality on wealth inequality. As rich households save a higher share of their permanent income than poorer ones, a more skewed permanent labor income distribution increases aggregate savings, everything else equal. However, in general equilibrium, with a realistic market structure, an increase in aggregate savings increases mostly the price of capital, not its quantity. This has little impact on the marginal productivity of capital and labor but creates capital gains that push up the top 1% wealth share.

We study how rising permanent labor-income inequality shapes monetary and fiscal transmission in a Heterogeneous-Agent New-Keynesian model with a non-homothetic taste for wealth. Higher inequality increases the share of hand-to-mouth households, raising aggregate MPCs and lowering the effective intertemporal elasticity of substitution. As a result, the direct effect of monetary policy weakens, while the indirect effect strengthen, leading to a larger output response. A higher share of capital gains generated by monetary policy are paid to wealthy households, making monetary policy more regressive. For fiscal policy, higher MPCs raise impact and cumulative multipliers and make deficit-financed expansions more likely to be self-financing. Finally, the fiscal response to a monetary policy shock becomes more important to determine the output response to a change in interest rate.

Monetary tightening can generate inefficient firms exits, by exacerbating firm illiquidity constraints. Contrary to the common belief that only small firms are affected, new evidence shows that large firms are vulnerable too, leading to large aggregate effects. This paper investigates why monetary tightening causes large firms to exit and explores the macroeconomic implications. In this paper, we study why monetary tightening can lead to large firms exit, and explore its macroeconomic implications. To do so, we develop a model of endogenous firm exit with financial frictions and partial irreversibility. Financial frictions imply that only productive firms are able to take on debt, making them highly exposed to interest rate changes, as partial irreversibility makes deleveraging costly. The quality of firm selection can therefore endogenously worsen during monetary tightening episodes, highlighting a potential need for support for large firms in distress.

Despite governments’ commitments to limit global warming to 1.5 degree Celcius, there is still investment in carbon-intensive capital. This paper uses a growth model featuring irreversible investment, capacity utilisation, clean and polluting capital to study this apparent paradox. It shows that current investment in polluting capital and CO$_2$ emissions are coherent with expectations of a future carbon tax, if investors also expect a bailout of polluting capital. This result implies that governments’ credibility can play an important role in reducing the cost of implementing an optimal carbon tax by committing not to bail out. However, there exists a temptation for a short-sighted government to boost output and consumption in the short run by announcing a future bailout.