Macroeconomics and Inequality

University Of Rochester, Rochester NY

Investigators

Abstract

The United States economy is one of the richest in the world, both in terms of per capita wealth and in terms of per capita output, but it is also an economy with very sharp contrasts between rich and poor. What is the source of this inequality, and should it concern economists and policy makers? Is it perhaps a natural, or even necessary, aspect of being the richest in the world, or does it reflect a failure that can be addressed with economic policy? And even if inequality per se is not a cause for concern, does it influence aggregate economic activity? Although much progress has been made, academic economists are not yet able to address the above issues in a quantitatively satisfactory way. First, few natural experiments are available to speak directly to the issues using purely empirical methods. Second, adequate economic theory is largely missing. This research addresses the second point: it aims to continue the development of the theory and numerical tools needed for a quantitative study of the sources of inequality and its interrelation with macroeconomics. The present project, in particular, is a continuation of an earlier project (NSF grant #9807760) by this investigator with collaborators. The work proceeds along several fronts, but the common theme is to both develop and apply methods that are of general use in quantitative-theoretical studies of macroeconomics and inequality. The central questions are rather basic ones: What determines how different people save, both in human and physical capital? How does technological change influence wage inequality? How does economic policy influence, and how is it influenced by, inequality? The project has specific applications, but most of the work is on questions of quite broad applicability. The subprojects are as follows: I. Origins of inequality: a. Savings: Why do households differ so much in their propensities to save? This project continues earlier work on the role of initial wealth differences and labor market luck, but also goes further: what determines "discount factors?" The approach here is one of psychology and economics; the psychology literature reports that many consumers seem to face "urges" to consume, and whether they do or not, and how they deal with the urges, seems to vary widely. b. Earnings: How are wage and human capital inequality influenced by technological change that is embodied in capital? Arguably, the bulk of the present and recent improve- ments in productivity take this form, and the existing work on the topic is quite limited. Here, the focus is on how frictions in the labor markets impact both accumulation of physical and human capital, and on how economic policy interacts with these frictions. II. Interactions between inequality and aggregates: a. Does the wealth distribution matter for macro? A further investigation of channels through which inequality-via the differences in propensities to save and work in the population-influences aggregates is undertaken here. b. The policy channel: How does economic policy affect inequality, and vice versa? This work includes (i) a political-economy study of redistribution and social insurance and (ii) a study of dynamic policy determination when policy makers are restricted by a lack of commitment.