Staff Reports
Income Inequality and Job Creation
Number 1021
June 2022 August 2023

JEL classification: D22, D31, E44, L25

Authors: Donggyu Lee, Sebastian Doerr, and Thomas Drechsel

We propose a novel channel through which rising income inequality affects job creation and macroeconomic outcomes. High-income households save relatively more in stocks and bonds but less in bank deposits. A rising top income share thereby increases the relative financing costs for bank-dependent firms, which in turn create fewer jobs. Exploiting variation across U.S. states and an instrumental variable strategy, we provide evidence for this channel. To study its aggregate implications, we build a general equilibrium macro model with heterogeneous households and heterogeneous firms. Calibrating the model to our empirical estimates, we show that growing top incomes account for 16 percent of the decline in the employment share of small firms since 1980, in part through less entry. Rising inequality also reduces the labor share and lowers aggregate output. Our model exercises highlight that ignoring the link between inequality and job creation understates welfare effects of income redistribution.

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Author Disclosure Statement(s)
Donggyu Lee
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Sebastian Doerr
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Thomas Drechsel
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
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