Inequality and Aggregate Demand

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We explore the transmission mechanism of income inequality to output.

In the short run, higher inequality reduces output because marginal propensities to con- sume are negatively correlated with income changes, but this effect is small in the data and in our model. In the long run, the output effects of income inequality are small if inequality is caused by more unequal fixed effects, but can be large if it reflects higher individual income risk. We provide a novel and general methodol- ogy for connecting partial and general equilibrium effects, and show that the two are closely connected under standard assumptions about the behavior of monetary policy. Our economy features a depressed long-run real interest rate, allowing us to quantify the potential contribution of income inequality to secular stagnation. 

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