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DP6485 | Wealth Inequality and Credit Markets: Evidence from Three Industrialized Countries

Publication Date

19/09/2007

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Abstract

Capital market theory predicts that the wealth distribution of an economy affects real interest rates. This paper empirically analyzes this relationship for the US, the UK and Sweden. We obtain that measures of wealth inequality are positively linked to the real rate on government securities in all three countries. This result is consistent with predictions from capital market equilibrium models with moral hazard such as Aghion and Bolton (1997) or Piketty (1997). Accordingly, rich individuals can only credibly commit to providing effort if the rate of return is not too high. When the rich are poorer, the rate of return has to be lower in order to guarantee entrepreneurial effort. Capital demand will therefore fall as inequality is reduced. The capital market is in equilibrium at a lower rate of return. The results bear important implications for economic growth and distributive policies.