A better understanding of the forces behind growing inequality and how households might respond differently to economic shocks and policy are key motivational factors in a new research project at BI, which studies the macro economic impact of differences in household’s consumption, income and wealth.

The project aims to contribute to fiscal and monetary policy analysis, as well as a better understanding of the forces behind growing economic inequality, thereby informing the current debate on the issue.

In macroeconomics, much theoretical progress has been made in understanding when distributions matter for aggregates. Newer so-called heterogeneous models deliver strikingly different implications for monetary and fiscal policies than what the traditional models do, and also allows to study the distributional implications of different policies across households.

Despite new trends and developments, the macroeconomic literature has addressed the implications of growing inequality only to a limited extent. Up until the Great Recession of 2008, it was widely believed that long-standing questions about economic aggregates, such as how to understand business cycles and the effects of monetary policy, could be studied without taking distributional considerations into account.

The project aims to combine a host of Norwegian data sources so as to obtain a detailed overview of the consumption and financial decisions of Norwegian households. Examples of these data sources used in a pseudonymized form are administrative tax records and possibly credit card and bank account data.

Lacking explanations

The Great Recession was somewhat of a watershed in macroeconomic research where the existing dominant models performed poorly in explaining the crisis and proved inadequate to address several of the most pressing policy questions that the crisis brought forth, such as: How do households’ debt levels, and their balance sheet composition in general, determine their response to macroeconomic policies? How will equity holders respond when their assets suddenly drop in value? To what extent do family members provide each other with insurance in response to drastic labour market events? And how important is entrepreneurship, which typically is severely hit by an economic crisis, for individual wealth mobility and economic performance more generally?

“Our empirical efforts will be disciplined by the recent developments in modelling macroeconomic phenomena with microeconomic heterogeneity. Our overarching motivation is to quantify the type of micro heterogeneity that matters for macroeconomic theory and thereby inform the development of current and future macroeconomic models,” says Associate professor Andreas Fagereng at BI Norwegian Business School.

Fagereng has been given a ERC grant for his research project, a grant targeting outstanding researchers who present research projects with expected ground-breaking results, and who have demonstrated scientific maturity a few years after completing their doctorate degree.

The grant has allowed him to establish a team of researchers from Europe, US and local members from the University of Oslo, Statistics Norway and Norges Bank in addition to BI colleague Gisle Natvik. The official start date of the project was 1 May 2020.

“We consider an important part of future macroeconomics to be the study of distributions – and current models have come a long way. However, sufficient empirical evidence is missing. Further progress in this field requires more documentation and sharper identification of the key mechanisms highlighted by the models, “ says Fagereng.

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