Capital Risk, Fiscal Policy, and the Distribution of Wealth

Andrea Modena () and Luca Regis ()

CRC TR 224 Discussion Paper Series from University of Bonn and University of Mannheim, Germany

Abstract: We develop a continuous-time model of a production economy where households face leverage constraints, uninsurable labour income shocks, and capital depreciation risk. We derive a numerical approximation of the model’s competitive equilibrium and compare it with a benchmark economy with no capital risk. Introducing capital risk generates a positive risk premium while fostering aggregate capital accumulation and safe asset demand. At the same time, it exacerbates wealth inequality by making poor households’ net worth more volatile than their wealthier peers. In this framework, we investigate the impact of fiscal policy on households’ wealth distribution and welfare. Fiscal policy influences the equilibrium wealth distribution by changing the risk premium. This channel unevenly impacts households’ consumption and asset allocation decisions, depending on their wage and net worth levels. Tax cuts on risky capital may benefit wealthy or poor households, depending on whether they are financed by raising taxes on safe assets or labour.

Keywords: fiscal policy; incomplete market; portfolio choices; wealth distribution (search for similar items in EconPapers)
JEL-codes: C61 E21 E62 G11 (search for similar items in EconPapers)
Pages: 30
Date: 2023-08
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:bon:boncrc:crctr224_2023_454

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