Causes and consequences of inequality in macroeconomics

Interests in inequality in macroeconomics has been rapidly growing, due to its deepening in the reality. Bewley-Hugget-Aiyagari model is a classical model in this study. Despite being innovative with realistic assumptions such as idiosyn cratic shock and borrowing constraint, it also has drawback such that it does not generate high enough wealth inequality under reasonable calibrations. Also, since Krusell and Smith (1998) argued, there has been a a consensus that the aggregates are the most important rather than heterogeneity. However, as lots of research have followed to overcome the model’s limitations there are now a large number of heterogeneous agent papers, investigating the causes of inequality as well as the effect of fiscal and monetary policy.

This thesis stands in line with these studies, exploring topics regarding the causes and consequences of inequality. First chapter suggests loss aversion preference as a sources of high wealth inequality. Using Aiyagari type heterogeneous agents dynamic stochastic general equilibrium (DSGE) model, it shows that with loss aversion, agents have an extra motive for precautionary savings especially among the wealthier agents and hence, it affects the upper tail of the wealth distribution. Quantitative analysis shows that, under standard parameterisation of the utility function, the model achieves a significant increase in the wealth inequality and the savings rate along with the degree of loss aversion. Higher kurtosis and positive skewness suggest a thicker upper right tail, implying more wealth ii concentration among wealthier agents. The shape of distribution in some Cumu lative Density Function (CDF) and Probability Density Function (PDF) figures also imply that loss aversion can generate a bimodal distribution, with rather less inequality at the very top between 0.1 percent and 1 percent, as implied by Inverted Pareto coefficients.

The second chapter assumes that there is ex-ante inequality in the income and wealth. Differentiating two household types as in existing Two-Agent New Keynesian (TANK) models, it analytically shows that the supply side inflation from the essential sector can shrink the overall demand and aggravate the inequality, as we recently observed. By differentiating essential and normal consumption goods under quasi-linear utility function, it leads to deriving the threshold income as a function of essential goods price. By this threshold income, households are split into two types, i.e., the rich (unconstrained) and the poor (constrained). Hence, household fraction is determined by the threshold income, rather than being an exogenous probability parameter, it is now changeable by the essential price. And it suggests a new methodology for inequality analysis. Having firms in both essential and normal sectors to follow the standard New Keynesian (NK) model with price rigidity, this chapter discovers that the essential mark-up shock, among other shocks, contracts the overall consumption, raises up the fraction of the poor households, and can increase consumption and income gap.