2018/03 LEM Working Paper Series

The “Rajan Hypothesis”: a counter-factual experiment

Matteo Coronese and Isabelle Salle
Income inequality; Distributional shocks; Under-consumption

  JEL Classifications
E70; C63; E03; E52

We integrate a centralized wage bargaining process into an otherwise standard DSGE model with a financial accelerator to simulate distributional shocks in the presence of financial instability. Our framework provides a counterfactual analysis of the effects of the observed decrease in the labor share when no concomitant rise in households’ credit offsets the adverse effect on consumption. The result is a prolonged under-consumption recession that outweighs the initial boost in investment.
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