Income polarization and stagnation in astochastic model of growth: When the demand side matters

This contribution is motivated by two stylized recent observations: the slowdown in growth and simultaneous income polarization in many advanced economies. We suggest an approach that departs from a typical endogenous growth model. As we want to look at polarization effects, we model two income groups, labor and financial wealth owners. The two groups have different intertemporal choices which lead to group-specific consumption and savings patterns. As a result, consumption and endogenous investments define an independent demand side. Prices are generally flexible. However, there is a mismatch which is related to stochastic aggregate demand and firm specific frictions. Adjustments to the mismatch are modeled through a reallocation of resources to a search and matching process. As an important result, firms and costumers find a market equilibrium growth path below potential growth. Thus, we obtain a hybrid neoclassical-keynesian model of growth. Even if potential growth can be generated only by the supply side, endogenous effective demand restricts the level and growth rate of the income path. In order to show that this path is a steady-state equilibrium path we suggest an unconventional equilibrium concept in a stochastic environment. We define an equilibrium as being stationary if all expected values are the effectively realized values (no systematic error in expectations). This equilibrium concept relates to the Nash idea of individual stationary behavior. Overall, our hybrid model bridges a gap between neoclassical (and endogenous growth) ideas and Keynesian ideas (demand restrictions) of economic growth.