Crisis Propagation in a Heterogeneous Self-Reflexive DSGE Model

TL;DR

This paper develops a heterogeneous self-reflexive DSGE model to analyze how economic crises propagate across different social strata, highlighting the roles of income inequality and social network segregation in crisis dynamics.

Contribution

It introduces a novel DSGE framework incorporating social networks and heterogeneity, revealing how crisis propagation varies with network structure and income inequality.

Findings

Crises can be confined within high or low income groups depending on parameters.

Segregated social networks amplify contagion effects and crisis severity.

Higher income inequality can reduce the likelihood of widespread crises.

Abstract

We study a self-reflexive DSGE model with heterogeneous households, aimed at characterising the impact of economic recessions on the different strata of the society. Our framework allows to analyse the combined effect of income inequalities and confidence feedback mediated by heterogeneous social networks. By varying the parameters of the model, we find different crisis typologies: loss of confidence may propagate mostly within high income households, or mostly within low income households, with a rather sharp crossover between the two. We find that crises are more severe for segregated networks (where confidence feedback is essentially mediated between agents of the same social class), for which cascading contagion effects are stronger. For the same reason, larger income inequalities tend to reduce, in our model, the probability of global crises. Finally, we are able to reproduce a perhaps counter-intuitive empirical finding: in countries with higher Gini coefficients, the consumption of the lowest income households tends to drop less than that of the highest incomes in crisis times.