Abstract
We argue that the relationship between wealth inequality and fiscal multipliers depends crucially on the type of fiscal experiment used, and on the measure of wealth distribution. We calibrate an overlapping generations model with incomplete markets for different European economies and use Household Finance and Consumption Survey (HFCS) data to compare fiscal multipliers when models are calibrated to match the distribution of gross vs. net wealth. We find a negative relationship between fiscal multipliers and wealth inequality when considering fiscal consolidation programs, in contrast to fiscal expansion experiments which are standard in the literature. The underlying mechanism relies on the relationship between the distribution of wealth and the share of credit‑ constrained agents. We examine the role of household balance sheet compositions regarding asset liquidity and find that when calibrating the model to match liquid wealth, the relationship between wealth inequality and fiscal multipliers is much stronger.
Highlights
The 2008 financial crisis brought a renewed interest in fiscal policy
We find a negative relationship between fiscal multipliers and wealth inequality when considering fiscal consolidation programs, in contrast to fiscal expansion experiments which are standard in the literature
This paper analyzes the impacts of wealth inequality on a fiscal consolidation program financed either by austerity or by taxation
Summary
The 2008 financial crisis brought a renewed interest in fiscal policy. Until 2008, the debate around monetary policy effects dominated over fiscal policy. Models that are calibrated to match the net wealth distribution will produce aggregate marginal propensities to work and consume in response to the fiscal shocks that are likely to be biased, and affect the size of the output response (see Domeij and Floden (2006)) This difference can be correctly analyzed since the ECB brought a new dataset, the Household Finance and Consumption Survey, that can be used to perform cross‐country studies taking into account the asset composition of the wealth distribution. The difference to Brinca et al (2016) is that, for fiscal consolidation shocks, higher wealth inequality implies lower multipliers: as debt‐over‐GDP decreases, there is a crowd‐in effect of assets into productive capital, which increases the marginal product of labor and the net present value of agents’ lifetime income.
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