Heterogeneous Asset Returns, Wealth Inequality and Monetary Policy

Abstract

This dissertation aims to study the interactions between heterogeneity in asset returns and wealthinequality in the US from both an empirical and theoretical perspective with implications for monetary policy. Specifically, the first chapter explores the short term distributional consequences for US consumption from changes in the federal funds rate through the wealth inequality channel. In the second chapter, three major sources behind the dramatic increase in wealth inequality over the past half-century in the US are investigated. In the third chapter, I examine the impact of U.S. household wealth on their mortgage refinancing and consumption decisions, revealing the interlinkage between wealth inequality and housing markets. In the first chapter, I study how different returns and prices of housing and equity interactwith heterogeneous marginal propensities to consume across households in the wealth distribution to cause uneven consumption effects from changes in the federal funds rate. The analysis unveils varying group susceptibilities to monetary policy, underscoring the diversified effects based on housing tenure, age, and borrowing constraints. Chiefly, a 1% federal funds rate drop increases consumption of outright homeowners by more than double relative to mortgage holders (3.02% vs 1.43%), yields a 1.72% rise for older individuals with a 1.29% boost for younger ones. The middle 50- 90% net wealth distribution gain nearly twice as much as the bottom 50% (1.51% vs 0.8%). Besides identifying winners and losers, I also study how the distribution affects aggregate US consumption. A 1% reduction in the federal funds rate increases overall consumption by 1.63%. There also exists significant asymmetries at all levels with 1% increase curtailing aggregate consumption by merely 1.02%, signifying hurdles in achieving a ’soft landing.’ In the second chapter, co-authored with my Co-Chairs Professor Chen and Professor Greaney,we undertake a comprehensive empirical analysis using the Survey of Consumer Finances (SCF) data to quantify how differences in asset returns, inheritances, and investment opportunities such as costs of homeownership and equity-market participation explain observed inequality trends, including generational and racial wealth gaps for different birth cohorts in the US. In the 1960s, the average household of age 20-39 had one third the wealth of a 60+ household; in 2019, this share was less than one-sixth. At age 30, the average Black Millennial household has less than 5% of average wealth; in earlier generations, this ratio was more than twice as high. We use a dynamic heterogeneous-agent model that captures household’s lifetime decisions regarding how much to save, whether to rent or own, and how to adjust portfolios in response to changing market conditions. We calibrate the model to the US economy to investigate possible broadly motivating factors behind the dramatic increase in wealth inequality over the past half-century. We can evaluate the role of mitigating measures like tax policies and reducing barriers to asset market participation. In the third chapter, empirical analysis from the SCF data corroborates the interlinkagebetween household debt & their hand-to-mouth status. Further evidence from refinance approvals indicate strong demand for home equity extraction in periods of high unemployment often aided by higher house prices. I rationalize the measurement by setting up a 3 period partial equilibrium model with heterogeneous preferences to investigate the importance of considering mortgages distinctly from other illiquid assets in the determination of hand-to-mouth status. Simple counterfactuals in a calibrated model strongly matched the trends in house prices, unemployment and mortgage refinancing during the pandemic. Better estimates of the share of hand-to-mouth households is imperative for understanding the transmission and redistributive effects of monetary policy & fiscal transfers through household consumption.