Growing with inequality: a DSGE model with heterogeneous human capital and endogenous economic growth

Abstract

ABSTRACT We try to explain the simultaneous increases in economic growth and income inequality in China with a heterogeneous endogenous growth-based DSGE model. It is found that: First, our model can simulate the positive correlation between economic growth and income inequality in China. China’s economic development has created better conditions and incentives for the accumulation of human capital of workers with high initial human capital, thus stimulating them to contribute more to economic growth, but this widens the income inequality simultaneously. Second, the change in economic growth and the change in income inequality also exhibit a positive correlation under the influence of various policy shock. Any shock that raises economic growth, such as different types of technology shock and investment shock (after 8 quarters), will correspondingly widen income inequality. Conversely, any shock that reduces economic growth, such as fiscal spending shock, interest rate shock and investment shock (before 8 quarters) will correspondingly reduce income inequality. Third, the government’s preference for workers with high initial human capital in the implementation of macroeconomic policies determines the positive correlation between the change in economic growth and in income inequality. Workers with high initial human capital are central to the effectiveness of macroeconomic policies.