Inequality and Financial Markets - A Simulation Approach in a Heterogeneous Agent Model

Abstract

This paper presents a dynamic model with N heterogeneous consumers in the presence of financial markets allowing for saving and lending. Instead of adjusting their consumption based on utility maximization, agents use heuristics as suggested by behavioral theory. The main result of the model is that increased income inequality transforms into increased net worth inequality leading to increased price volatility on the market for durables. Unequal societies moreover are characterized by a current account surplus resulting from strong savings. Price volatility also increases if we increase heritage defined as the ratio of stock level of initial endowment to annual income. Medium size heritage on the other side increases the number of middle class households leading to a balanced current account. Extreme low or extreme high values for heritage contribute to a net debt situation with foreigners