Endogenous Growth, The Distribution of Wealth, and Optimal Policy Under Incomplete Markets and Idiosyncratic Risk

31 Pages Posted: 15 Jun 2012

Date Written: May 31, 2012

Abstract

This paper combines the standard incomplete markets model of uninsurable idiosyncratic risks and borrowing constraints with the Arrow/Romer approach to endogenous growth to analyze the interaction of risk, growth, and inequality, the latter also endogenously determined in equilibrium. We derive conditions on existence and nonexistence of balanced growth paths. Major results include that growth, inequality, and risk are positively related in our model, but we also identify a hump–shaped relationship between welfare and risk, indicating a tradeoff relationship between risk–pooling and growth in the determination of welfare. We employ the prototypical policy implications of the underlying growth model (i.e. subsidizing capital returns) and find that the tax–transfer scheme positively affects growth while simultaneously reducing wealth inequality in the economy. The benefits and burdens of the underlying policy are unequally distributed, which raises the issue of politico–economic equilibria. We provide results on majority voting, finding that that the median voter prefers less than optimal subsidies on investment. Interestingly, the society might even vote against a policy providing full insurance against idiosyncratic risk, because welfare losses of lower growth more than offset welfare gains from lower risk.

Keywords: endogenous growth, wealth distribution, idiosyncratic risk, borrowing constraints, heterogeneous agents, optimal policy

JEL Classification: O400, D300, D800, D900, C600

Suggested Citation

Clemens, Christiane and Heinemann, Maik, Endogenous Growth, The Distribution of Wealth, and Optimal Policy Under Incomplete Markets and Idiosyncratic Risk (May 31, 2012). CESifo Working Paper Series No. 3832, Available at SSRN: https://ssrn.com/abstract=2084071 or http://dx.doi.org/10.2139/ssrn.2084071

Christiane Clemens (Contact Author)

University of Bielefeld ( email )

Universitätsstraße 25
Bielefeld, NRW 33613
Germany

Maik Heinemann

University of Potsdam ( email )

August-Bebel Strasse 89
Potsdam, 14482
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
74
Abstract Views
661
Rank
645,895
PlumX Metrics