When does inequality freeze an economy?

TL;DR

This paper models how increasing wealth inequality reduces economic liquidity, leading to congestion and potential economic arrest when inequality reaches a critical threshold.

Contribution

It introduces a simplified economic model linking wealth inequality to liquidity and identifies a critical point where the economy freezes.

Findings

Higher wealth inequality decreases overall liquidity.

Increased inequality causes financial resource concentration.

Economy stalls when Pareto exponent reaches one.

Abstract

Inequality and its consequences are the subject of intense recent debate. Using a simplified model of the economy, we address the relation between inequality and liquidity, the latter understood as the frequency of economic exchanges. Assuming a Pareto distribution of wealth for the agents, that is consistent with empirical findings, we find an inverse relation between wealth inequality and overall liquidity. We show that an increase in the inequality of wealth results in an even sharper concentration of the liquid financial resources. This leads to a congestion of the flow of goods and the arrest of the economy when the Pareto exponent reaches one.