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posted on 31 January 2016

Pikettys Book And Macro Models Of Wealth Inequality

from the Chicago Fed

-- this post authored by Mariacristina De Nardi, Giulio Fella, and Fang Yang

Thomas Piketty's book Capital in the Twenty-First Century is, in the author's own words, a book about the history of the distribution of income and wealth. Among other interesting and important facts, the book quantifies the evolution of wealth inequality and wealth concentration over time and across a number of countries.

Wealth is highly concentrated, and its distribution is skewed with a long right tail; a small number of very rich individuals hold a large share of total wealth in the economy. The book documents that the share of aggregate wealth in the hands of the richest individuals displays a U shape over time, trending downward for most of the twentieth century and then increasing from the 1980s onward. In other words, wealth has become more concentrated over the past 35 years.

Although Piketty discusses a number of mechanisms affecting wealth inequality - the role of tax progressivity, top income shares, and heterogeneity in saving rates and inheritances - he singles out a "fundamental force for divergence" in the size of the difference between the post-tax rate of return on capital and the rate of output growth. According to this mechanism, a higher post-tax rate of return increases the rate at which past accumulated wealth compounds, thus magnifying wealth inequality. Conversely, a higher rate of output growth reduces wealth concentration by increasing labor earnings and, therefore, saving by individuals whose main source of income is labor earnings.

In Piketty's view, the effect of these two forces is big, and changes in the rate of capital taxation and output growth can explain the dramatic evolution of wealth concentration over the past century. Importantly, according to Piketty, it is the difference between the net rate of return on wealth and the output growth rate that affects wealth inequality. Furthermore, he does not distinguish between changes in the rate of output growth due to changes in total factor productivity (TFP) rather than in the population growth rate.

[click on image below to continue reading]

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