Disentangling the Distributional Effects of Financial Shocks in the Euro Area

Abstract

We estimate the dynamic distributional effects of financial shocks in the Euro Area using survey-based microdata on personal incomes. We find that positive financial shocks increase inequality, with heterogeneity across different income groups. Much of the response emerges in the tails of the income distribution. By decomposing individual incomes into financial and labor components, we identify two distinct transmission mechanisms: financial income inequality rises, likely due to differences in asset holdings. In contrast, labor income inequality increases through a skill premium channel. We then consider a nonlinear model framework, distinguishing the sign of the shock, allowing us to document the presence of asymmetric effects. While positive shocks lead to income disparities, adverse shocks have the opposite effect. Notably, middle-income groups are only affected following a negative shock, highlighting differential vulnerabilities across the income distribution.