Credit constraints, growth and inequality dynamics

Abstract

This paper examines how credit constraints a¤ect the dynamics of wealth and thereby the dynamics of capital and output growth. We develop standard Ak growth models that display transitional dynamics, contrary to general belief, once the com- plete credit markets assumption is relaxed. The mechanism is that credit constraints make individual productivity di¤erences persist, which in turn leads to the persis- tence of income inequality. The dynamics of inequality is jointly determined with the dynamics of aggregate capital. The economy thus passes through a transitional period of inequality, individual and aggregate capital dynamics before it converges to a long-run balanced growth path. The application of the model to the analysis of intergenerational mobility and inequality dynamics suggests substantial economic and policy signi cance. In particular, introducing credit constraints to the Barro Ak model, public investment could have an indirect impact on growth via its e¤ect on inequality and mobility.