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Abstract
We study the impact of an increase in permanent labor income inequality on the transmission of monetary shocks on the real economy. In a Heterogeneous-Agent New-Keynesian model with standard preferences, we show that the distribution of permanent labor income is neutral with respect to monetary policy shocks. However, this model cannot account for the observed relationship between permanent income and consumption-saving behavior. Including a non-homothetic taste for wealth allows us to match this relationship, and breaks the neutrality result. The direct substitution effect from a monetary policy shock is weakened while indirect effects are stronger. The rise in permanent labor income inequality makes households hold wealth more for a present motive rather than for an intertemporal-substitution motive. As a result, the aggregate elasticity of intertemporal substitution is weakened while the aggregate static MPC is strengthened. In a realistic two-asset HANK model, we quantify the change in the composition of a monetary shock. We observe a rise in the magnitude of a monetary policy shocks as the increase in indirect effects more than outweighs the fall in the direct effect.
Citation
@techreport{MS24,
author = {Eustache Elina and Raphaël Huleux},
year = {2024},
title ={From Income to Wealth Inequality in the U.S.: General Equilibrium Matters}}