Macro Implications of Inequality-driven Political Polarization

This paper builds a model of heterogenous agents, incomplete markets and idiosyncratic shocks extended with a political mechanism that allows for realistic party competition. Higher inequality leads to more disperse policy preferences, to which parties respond endogenously distancing themselves from median voter preferences. The polarization of party proposals leads to greater uncertainty before elections, as well as greater policy switches after them, with significant macroeconomic effects. Results are in line with previous empirical evidence linking inequality, polarization and macroeconomic performance. The model is solved introducing political quasi-aggregation, and can be extended to analyze different economic policies and alternative political institutions.