We are not as wealthy as we thought we were, and its consequences

Erzo G.J. Luttmer has an interesting new paper and model (pdf):

When consumers realize they are not as wealthy as they thought they were, they reduce consumption and save more. This lowers the real interest rate, making the development of new projects more profitable. The price of new projects rises relative to the price of consumption. The Stolper-Samuelson theorem therefore implies an increase in managerial wages, and a decline in worker wages. If the economy operates in a region where the supply of worker labor is sufficiently elastic, this can lead to a significant reduction in the employment of workers, while managers are reallocated towards developing new projects.

You should not believe in this to the exclusion of traditional aggregate demand channels, but still it is an interesting way to visualize some supplemental effects.  Note that workers who are quite good at building new projects will earn premia, while others, in the declining sectors, are losing their jobs.  That is not so different from the world we live in.

For the pointer I thank Paddy Carter.


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