Between Scylla and Charybdis: Income Distribution, Consumer Credit, and Business Cycles

We introduce a macroeconomic model with heterogeneous households and anaggregate banking sector in order to analyze the impact of rising income inequalityunder different credit scenarios. Growing inequality produces debt-led consumptionboom dynamics when the banking sector is characterized by a lower capital requirementand a higher willingness to lend. Instead, when inequality rises but the banking sectoris highly regulated, aggregate demand and output fall. Our results also yield newinsights on the appropriate fiscal policy reaction to stabilize the economy: acting onthe progressivity of the tax system seems more effective than a proactive countercyclicalfiscal policy