Asset purchases, limited asset markets participation and inequality

Abstract

This paper examines the impact of quantitative easing (QE) on aggregate demand and inequality in a restricted financial participation economy. It shows that when wages are sticky and asset market participation is high, QE stimulates aggregate demand and reduces income and consumption inequality. Conversely, if wages are flexible and asset market participation is low, QE can reduce aggregate demand and raise inequality. To study these phenomena, I build and calibrate a New-Keynesian dynamic, general equilibrium model with sticky wages for the Euro Area (EA) that incorporates limited assets market participation, financial frictions and that allows central bank purchases from banks and households. Bond purchases increase aggregate demand and benefit financially restricted households more due to the dominance of QE’s indirect effects, reducing income and consumption inequality. The stimulating effects are conditional on the level of wage stickiness and thus the cyclicality of profits. When wages are flexible and thus profits countercyclical, low financial participation levels invert QE’s positive effects. Using an external instrument SVAR, I find that QE was stimulative and profits in the EA move pro-cyclically, supporting the sticky wage specification of the model. The sticky wage specification, combined with the high level of asset markets participation in the EA, make the QE a stimulating and redistributive tool for the region.