Starting observation expost Eggertsson and Krugman 2012 Distributional

Starting observation (ex-post) • Eggertsson and Krugman (2012) ─ Distributional shocks matter ex-post in the presence of ZLB type of constraints. • Series of papers by Jorda, Taylor and Schularik provide some fascinating historical evidence ─ Caution: not clear in the empirical literature that the ZLB is “necessary” ─ Possible tension with theory. ─ Would be nice to explore other possible frictions • Other work

Can monetary policy solve this problem? • Not really

Ex-ante decision making • Is ex-ante borrowing / lending decision going to incorporate the ex-post (stochastic) macro effects of debt? ─ No, there is an “aggregate demand externality” ─ d vs. D ─ Get inefficient outcome even with complete markets ─ Farhi and Werning, Korinek and Simsek

Credit cycles and inequality • The discussion has to involve income and wealth inequality as well ─ Lenders and borrowers differ systematically ─ The paper is agnostic about the “timing” of credit cycles ─ But evidence suggests that the “credit cycle” is related to rising inequality ─ Could credit cycle be a GE “response” to disequilibriating forces?

Relevant forces outside of model • Non-standard preferences ─ What if a quarter to one-third of the population was myopic? • Fire sale externality ─ Equally important • Employment feedback

Mandating change? • Mandating / subsidizing state-contingent financial contracts that automatically redistribute towards the more constrained agents ex-post • Getting rid of the bias induced by capital regulation • Getting rid of the bias induced by tax policy • Our financial regulation and tax policy makes no sense from a macro stability perspective. ─ This paper crystallizes some of the core issues in this debate.

Buying a $200 K Home $120 $100 $80 $60 $40 $20 $0 Your Equity Mortgage

House Prices Drop 40% $120 $100 $80 $60 $40 $20 $0 Your Equity Mortgage

Concentration of Losses ØDebt concentrates risk on the debtor – the lender largely escapes unscathed ØWho are lenders? Debt and inequality naturally connected

The Rich Lend to the Poor

The Distribution of Losses Matters!

The aggregate demand feedback

The employment feedback

The fire-sale feedback