 |
This paper advances the hypothesis that the intensity of status preferences negatively depends on the average wealth of society (endogenous dynamic status effect), in accordance with empirical evidence. Our behavioral driven theory is able to replicate the contradictory historical facts of an increasing savings rate along with declining returns on capital over time. Employing these results, we are also able to explain the observed historical dynamics of income inequality as an implication of our hypothesis. In particular, our theoretical model implies that, as an economy develops, the savings rate increases (for plausible parameter values) during transition. Convergence to a balanced growth path requires the level of the (increasing) savings rate to be lower compared to a standard growth model, thereby a lower rate of capital accumulation as well as –speed of convergence (SOC). This benefits the wealthy households relative to poor ones, as the rate of interest declines at a lower rate during transition. Therefore, the endogenous dynamic status effect contributes to a rise (to a lower decline) in wealth inequality. Along the same lines, we analyze the more recent behavior of inequality in response to changes in wealth (income) induced by productivity shocks. Under a positive productivity shock, in economies with a strong enough endogenous dynamic status effect, inequality increases – a fact that we experience in many countries around the globe nowadays.
