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Board of Governors of the Federal Reserve System (U.S.)
Finance and Economics Discussion Series
Income Inequality, Financial Crises, and Monetary Policy
Isabel Cairo
Jae W. Sim
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.


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Isabel Cairo & Jae W. Sim, Income Inequality, Financial Crises, and Monetary Policy, Board of Governors of the Federal Reserve System (U.S.), Finance and Economics Discussion Series 2018-048, 19 Jul 2018.
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Keywords: Monetary policy ; Credit ; Financial crises ; Income inequality
DOI: 10.17016/FEDS.2018.048
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