Posted on 23 October 2018
Lukas Nord has been awarded the prize for the best 1st year summer project in 2018 for his paper titled “Heterogeneous inflation expectations and the cross-sectional distribution of wealth”. The paper analyses the extent to which heterogeneity in inflation expectations (HIE) can generate wealth inequality. This seems relevant in light of the ample evidence of large persistent HIE across individuals and households. Intuitively, HIE is very similar to heterogeneity in time preferences (a popular way of generating enough wealth inequality). However, Lukas shows, both analytically and through a carefully designed quantitative exercise, that there is an important difference. A lower discount rate of the future (more patient individuals) affects the substitution effect leading to larger savings and wealth, while a lower expected inflation rate (i.e., a higher real interest rate) also generates an income effect that could offset (at least partially) the substitution effect. This implies that HIE with a similar inter-temporal substitution effect as time preference heterogeneity will have a smaller effect on wealth inequality. Then he models and estimates the process of inflation expectations across households to calibrate a model to the US economy and shows that HIE nevertheless increases wealth inequality significantly. Yet, it is still not able deliver enough wealth concentration at the top of the distribution, precisely because of the income effect. This implies that both types of heterogeneity may be required to reproduce the stylized facts about the wealth distribution in the US.
Congratulations for an excellent paper!