DP14364 Shocks, Frictions, and Inequality in US Business Cycles

Author(s): Christian Bayer, Benjamin Born, Ralph Luetticke
Publication Date: January 2020
Date Revised: November 2020
Keyword(s): Bayesian estimation, business cycles, Income inequality, incomplete markets, Monetary and Fiscal Policy, Wealth Inequality
JEL(s): C11, E32, E63
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14364

How much does inequality matter for the business cycle and vice versa? Using a Bayesian likelihood approach, we estimate a heterogeneous-agent New-Keynesian (HANK) model with incomplete markets and portfolio choice between liquid and illiquid assets. Even when the model is estimated on aggregate data only and with only a set of shocks and frictions along the lines of Smets and Wouters (2007), it reproduces observed US inequality dynamics. In other words, the model is successful in simultaneously accounting for cycle and distribution. Output stabilization via monetary or fiscal policy also stabilizes inequality.