Labor income has been declining as a share of total income earned in the United States for the past three decades. We look at the past effect of the labor share decline on income inequality, and we study the likely future path of the labor share and its implications for inequality.

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Occupation charges paid by France to Nazi Germany represent one of the largest international transfers and contributed significantly to the German war effort. We employ a neoclassical growth model that incorporates essential features of the occupied economy to assess the welfare costs of the policies that managed the payments to Germany. Our lower bound estimates show that occupation payments required a severe cut in consumption. A draft of labor to Germany and a reduction of real wages added to this burden. Management of the accumulated domestic debt required large budget surpluses; but post-Liberation inflation slashed the real debt.“Ils ne nous ont rien enlevé de vive force; ils ont toujours tout acheté correctement; mais ils nous ont tout payé avec de l'argent qu'ils nous avaient volé.”1

We study the macroeconomic implications of the debt overhang distortion. In our model, the distortion arises because investment is non-contractible-when a firm borrows funds, the debt contract cannot specify or depend on the firm's future level of investment. After the debt contract is signed, the probability that the firm will default on its debt obligation acts like a tax that discourages new investment by the firm, because the marginal benefit of that investment will be reaped by the creditors in the event of default. We show that the distortion moves counter-cyclically-it increases during recessions, when the risk of default is high. Its dynamics amplify and propagate the effects of shocks to productivity, government spending, volatility and funding costs. Both the size and the persistence of these effects are quantitatively important. The model replicates important features of the joint dynamics of macro variables and credit risk variables, like default rates, recovery rates and credit spreads.

We study the macroeconomic implications of the debt overhang distortion. In our model, the distortion arises because investment is non-contractible-when a firm borrows funds, the debt contract cannot specify or depend on the firm's future level of investment. After the debt contract is signed, the probability that the firm will default on its debt obligation acts like a tax that discourages new investment by the firm, because the marginal benefit of that investment will be reaped by the creditors in the event of default. We show that the distortion moves counter-cyclically-it increases during recessions, when the risk of default is high. Its dynamics amplify and propagate the effects of shocks to productivity, government spending, volatility and funding costs. Both the size and the persistence of these effects are quantitatively important. The model replicates important features of the joint dynamics of macro variables and credit risk variables, like default rates, recovery rates and credit spreads.