Abstract
The causes and consequences of the cyclical fluctuations in the top compensation share (TCS) and top capital income share (TKIS) are studied through the lens of an estimated two-agent New Keynesian model, featuring top and middle-class earners, capital-skill complementarity, and differences in workers' market power and investment opportunities. Heterogeneous wage developments are important for the TCS fluctuations. Variations in demand and firms’ pricing power are important for the TKIS fluctuations and the post-1980 reduction in the cyclicality of top shares. Although income heterogeneity has moderate effects on the sources of output cycles, it has considerable implications for labor market fluctuations. The monetary policy effectiveness decreases (increases) with the TCS (TKIS). Responding to inequality affects policy trade-offs little.
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