DP14118 Capital, Income Inequality, and Consumption: the Missing Link

Author(s): Florin Ovidiu Bilbiie, Diego R Känzig, Paolo Surico
Publication Date: November 2019
Date Revised: November 2019
Keyword(s): aggregate demand, Capital, Complementarity, Heterogeneity, Income inequality, monetary policy, multiplier
JEL(s): E21, E22, E32, E44, E52
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14118

A novel complementarity between capital and income inequality leads to a significant amplification of the effects of monetary policy on consumption: a multiplier of the multiplier. We characterize this finding analytically, in a simple saver-spender model, and quantitatively, in a framework featuring nominal rigidities, capital investment, idiosyncratic risk and heterogeneity in household saving and income. A fiscal policy that redistributes profits dampens the monetary policy effects, whereas redistributing capital income yields further amplification. Our model's testable prediction that consumption inequality is more counter-cyclical than income inequality in response to an interest rate shock is consistent with the available empirical evidence.