Inequality Causes Recessions: A Fallout from Ramsey's Conjecture
MPRA Paper from University Library of Munich, Germany
Ramsey's conjecture implies that a market economy tends toward a politically impossible form of extreme inequality (with "the thrifty enjoying bliss and the improvident at the subsistence level"). Because political actions are not systematic, but arbitrary or random, the combination of market and political forces leads to instability, sometimes full-fledged crisis. I show how the mechanisms of debt relief, redistribution and the uncertainty related to them could boil down to a discount rate shock for an aggregate representative agent. Furthermore, to make this shock possible into a simple Real Business Cycle (RBC) model, I propose a two-capital setup, which provides an improved solution to the interest-rate-inelasticity issue than the usual investment adjustment costs. Finally, I show the model's generality by adding wage rigidity and inflation. Considering the simplicity of the general equilibrium model, results provide rich narratives for recessions.
Keywords: Inequality; Credit crises; business cycles; discount factor heterogeneity. (search for similar items in EconPapers)
JEL-codes: E21 E22 E24 E32 E37 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
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