Title: New Golden Rule

Abstract:

The difference between the risk-free rate (r) and the growth rate (g) of an economy is one of the most important indicators in macroeconomics. This paper develops a heterogeneous agent, overlapping generations model in which both r and g are endogenous to each other. The growth rate is determined by parents’ investment in children’s human capital, while the equilibrium interest rate is determined by the level of parents’ savings. We show that whenever parents invest enough in their children for endogenous growth, the economy is dynamically inefficient. Moreover, longer life-spans reduce both r and g, while also raising earnings inequality, qualitatively replicating patterns observed in advanced economies in the past half-century. When overlapping generations of workers coexist with capitalists, who accumulate wealth according to a standard model of capital returns heterogeneity and financial frictions, an increase in investment risk or capitalist profits further lowers r, leading to an increase in wealth concentration and “stronger” dynamic inefficiency. Against this backdrop of dynamic inefficiency, we also revisit the question of whether taxing labor to subsidize capital is an effective tool for fast development in the context of developing (rather than advanced) economies.

Bio:

https://syleetim.github.io/