Dynamics of Assets, Liquidity, and Inequality in Economies with Decentralized Markets

Abstract

An algorithm for computing Dynamic Nash Equilibria (DNE) in an extended version of Kiyotaki and Wright (1989) (hereafter KW) is proposed. The algorithm computes the equilibrium profile of (pure) strategies and the evolution of the distribution of three types of assets across three types of individuals.It has two features that together make it applicable in a wide range of macroeconomic experiments: (i) it works for any feasible initial distribution of assets; (ii) it allows for multiple switches of trading strategies along the transitional dynamics.The algorithm is used to study the relationship between liquidity, production, and inequality in income and in welfare, in economies where assets fetch different returns and agents have heterogeneous skills and preferences.One experiment shows a case of reversal of fortune. An economy endowed with a low-return asset takes over a similar economy endowed with a high-return asset because, in the former economy, a group of agents abandon a rent-seeking trading behavior and increase their income by trading and producing more intensively. A second experiment shows that a reduction of market frictions leads both to higher income and lower inequality. Other experiments evaluate the propagation mechanism of shocks that hit the assets' returns.A key result is that trade and liquidity tend to squeeze income inequality.