Endogenous Growth, the Distribution of Wealth, and Optimal Policy under Incomplete Markets And Idiosyncratic Risk

33 Pages Posted: 31 Jan 2013

Date Written: December 30, 2012

Abstract

This paper combines the Aiyagari/Huggett–type standard incomplete markets model with the Arrow/Romer approach to growth to analyze feedback effects between growth and inequality, both endogenously determined in equilibrium. We derive conditions on existence/ 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 discuss transitory dynamics and policy implications. A growth policy simultaneously reduces 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: O4, D3, D8, D9, C6

Suggested Citation

Clemens, Christiane and Heinemann, Maik, Endogenous Growth, the Distribution of Wealth, and Optimal Policy under Incomplete Markets And Idiosyncratic Risk (December 30, 2012). Bielefeld Working Papers in Economics and Management No. 01-2012, Available at SSRN: https://ssrn.com/abstract=2208486 or http://dx.doi.org/10.2139/ssrn.2208486

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

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