Income Inequality, Financial Crises, and Monetary Policy

60 Pages Posted: 23 Jul 2018 Last revised: 21 Feb 2019

See all articles by Isabel Cairo

Isabel Cairo

Board of Governors of the Federal Reserve System

Jae Sim

Board of Governors of the Federal Reserve System

Date Written: 2018-07-19

Abstract

We construct a general equilibrium model in which income inequality results in insufficient aggregate demand, deflation pressure, and excessive credit growth by allocating income to agents featuring low marginal propensity to consume, and if excessive, can lead to an endogenous financial crisis. This economy generates distributions for equilibrium prices and quantities that are highly skewed to the downside due to financial crises and the liquidity trap. Consequently, symmetric monetary policy rules designed to minimize fluctuations around fixed means become inefficient. A simultaneous reduction in inflation volatility and mean unemployment rate is feasible when an asymmetric policy rule is adopted.

Keywords: Monetary policy, Credit, Financial crises, Income inequality

JEL Classification: E32, E44, E52, G01

Suggested Citation

Cairo, Isabel and Sim, Jae W., Income Inequality, Financial Crises, and Monetary Policy (2018-07-19). FEDS Working Paper No. 2018-048. Available at SSRN: https://ssrn.com/abstract=3217784 or http://dx.doi.org/10.17016/FEDS.2018.048

Isabel Cairo (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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