Adaptive learning and distributional dynamics in an incomplete markets model

Abstract

Recent research shows that several DSGE models provide a closer fit to the data under adaptive learning. This paper extends this research by introducing adaptive learning in the model of Krusell and Smith (1998) with uninsurable idiosyncratic risks and aggregate uncertainty. A first contribution of this paper establishes that the equilibrium of this framework is stable under least-squares learning. The second contribution consists of showing that bounded rationality enhances the ability of this model to match the distribution of income in the US. Learning increases significantly the Gini coefficients because of the opposite effects on consumption of the capital-rich and of the capital-poor agent. The third contribution is an empirical exercise that shows that learning can account for increases in the income Gini coefficient of up to 25% in a period of 28 years. Overall, these findings suggest that adaptive learning has important distributional repercussions in this class of models.