Wealth inequality and aggregate demand

Ederer, Stefan; Rehm, Miriam Working Paper Wealth inequality and aggregate demand ifso working paper, No. 4 Provided in Cooperation with: University of Duisburg-Essen, Institute for Socioeconomics (ifso) Suggested Citation: Ederer, Stefan; Rehm, Miriam (2019) : Wealth inequality and aggregate demand, ifso working paper, No. 4, University of Duisburg-Essen, Institute for Socio-Economics (ifso), Duisburg This Version is available at: https://hdl.handle.net/10419/215636 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ uni-due.de/soziooekonomie/wp ifso working paper Jan Behringer Till van Treeck 2019 no.5 The Corporate Sector and the Current Account ifso working paper Stefan Ederer Miriam Rehm 2019 no.4 Wealth Inequality and Aggregate Demand uni-due.de/soziooekonomie/wp Wealth inequality and aggregate demand Stefan Ederera and Miriam Rehmb aAustrian Institute of Economic Research (WIFO) and Vienna University of Economics and Business (WU), [email protected]. bUniversity of Duisburg-Essen and Vienna University of Economics and Business (WU). Key words: Wealth, Distribution, Aggregate Demand JEL codes: D31, D33, E12, E21, E25, E64 2/23 Abstract The paper investigates how including the distribution of wealth changes the demand effects of redistributing functional income. It develops a model with an endogenous wealth distribution and shows that the endogenous rise in wealth inequality resulting from a redistribution towards profits weakens the growth effects of this redistribution. Consequently, a wage-led regime becomes more strongly wage-led. A profit-led regime on the other hand becomes less profit-led and there may even be a regime switch – in this case the short-run profit-led economy becomes wage-led in the long run due to the endogenous effects of wealth inequality. The paper thereby provides a possible explanation for the instability of demand regimes over time. 1. Introduction For decades, distribution (or more precisely, the functional distribution of income) and its implications for economic growth have been central to Post-Keynesian thought (Kaldor, 1955; Pasinetti, 1962; Kalecki, 1971; Steindl, 1952). Early Post-Keynesian models emphasize the ‘wage-led’ nature of growth: a rise of the profit share reduces aggregate demand and ultimately also capital accumulation (Rowthorn, 1981; Dutt, 1984; Taylor, 1985). Bhaduri and Marglin (1990) extend these models so as to allow for an ambiguous effect of a higher profit share: if saving rises less than investment, it follows that aggregate demand and capital accumulation increase; the economy is ‘profit-led’. The demand regime thus depends on the relative size of these effects, and the question whether it is wage- or profit-led is ultimately an empirical one, albeit with important policy implications. If an economy is wage-led, increasing the wage share would lead to a win-win situation of higher growth and lower inequality. In the case of a profit-led economy, however, the opposite holds, and policymaking thus faces a trade-off between growth on the one hand, and a less unequal functional income distribution on the other hand. The theoretical possibility of either wage- or profit-led growth in the Bhaduri and Marglin (1990) model sparked a lively debate among Post-Keynesians. 1 The better part of the literature revolves around the question whether the demand or growth regimes are empirically wage- or profit-led in various countries (Barbosa-Filho and Taylor, 2006; Stockhammer and Ederer 2008; Stockhammer et al. 2009; Onaran and Galanis 2014; Kiefer and Rada, 2015). Recently, however, some contributions question the stability of demand regimes and emphasize the difference between short- and long-run effects, which opens up the possibility of regime switching (Nikiforos and Foley, 2012; Palley, 2014a; Blecker, 2016; Nikiforos, 2016). Others show that the inclusion of the personal income distribution (Lavoie, 2009; Palley, 2014b; Carvalho and Rezai, 2016; Palley, 2017a) or financial variables (Palley, 1 For an overview of the wage-led/profit-led literature, see e.g. Stockhammer (2011), Lavoie and Stockhammer (2012), Setterfield (2016). 3/23 1994; Dutt, 2006; Bhaduri, 2011; Hein, 2012; Stockhammer and Wildauer, 2016) can affect the nature and the stability of the demand regime. So far, wealth and its distribution have not played a prominent role in the wage-/profit-led debate. However, apart from shaping economic capabilities, class positions, and political power, (productive) wealth also impacts aggregate demand since it entails profit income and thus co-determines the personal income distribution. Furthermore, wealth is distributed much more unequally than income. At the same time, the wealth distribution itself is influenced by the personal (and thus also the functional) income distribution, since wealth, apart from inheritances, is accumulated over time. Building on Pasinetti (1962), a small but growing literature extended Post-Keynesian models to include this cumulative dynamic (Dutt, 1990; Palley, 2012, 2017b; Taylor et al., 2015; Ederer and Rehm, 2019a, 2019b). This burgeoning strand of Post-Keynesian models of wealth inequality has not yet investigated the consequences for wage-led or profit-led demand. The two notable exceptions are Dutt (1990) and Palley (2017b). However, whereas the former only discusses wage-led demand, the latter only focuses on the short run. The goal of this paper is to close this gap. It builds a Post-Keynesian model in the tradition of Bhaduri and Marglin (1990), which incorporates an endogenous wealth distribution, and discusses the short- and long-run implications for the demand regime. In our model, a change in the functional income distribution does not only have immediate (short-run) effects on aggregate demand, but it also changes the distribution of wealth over time, which in turn has repercussions on both the distribution of income and on growth. The long-run effect of a rise in the profit share may thus differ from the short-run effect both quantitatively and qualitatively. In fact, we find that the wealth distribution plays a key role in determining whether an economy is wage- or profit-led in a Bhaduri-Marglin type model, and that it might lead to regime switching. The contribution of the paper is threefold: First, we bring the recently developed Post- Keynesian wealth models (back) into the wage-/profit-led debate and discuss the implications of an endogenous wealth distribution for the demand regime. Second, we thereby provide a possible explanation for the difference between the short- and long-run effects discussed in the literature and for (endogenous) switches between wage-led and profit-led regimes. Third, we embed the discussion on the effects of the personal income distribution and financial variables on the demand regime in a Post-Keynesian endogenous wealth model. The paper is structured as follows: Section 2 reviews the relevant literature. Section 3 describes the basic version of the model. Section 4 discusses the implications for wageled/profit-led demand in the short- and long-run. Section 5 presents some extensions to the model and their consequences for the demand regime. Section 6 concludes. 4/23 2. Literature In the decades following the seminal contribution of Bhaduri and Marglin (1990), an empirical literature developed which aimed at determining whether demand or growth regimes are wage- or profit-led. Many of these contributions find that small and open economies are profit-led, whereas larger, more closed economies or the world economy as a whole are wageled (e.g. Stockhammer and Ederer, 2008; Stockhammer et al., 2009; Onaran and Galanis, 2014). Others find that aggregate demand is profit-led for the USA (Barbosa-Filho and Taylor, 2006; Carvalho and Rezai, 2016) and for a panel of 13 OECD countries (Kiefer and Rada, 2015). Recently, the wage-led/profit-led debate has broadened into various directions. Three strands of this literature are relevant for our paper. First, some contributions question the stability of demand regimes (i.e. the supposition that they always remain wage-led or profit-led in any given economy). This literature emphasizes the possibility of regime changes. Bhaduri and Marglin (1990) already pointed out that the degree to which an economy is wage-led or profitled depends on the level of the profit share itself, so that a rising profit share would make a profit-led regime ever less profit-led, and vice versa. Some recent contributions argue that the effect of a change in the profit share on consumption, investment and net exports materializes differently over time (Blecker, 2016; Setterfield and Kim, 2017) or includes nonlinearities which open up the possibility of a regime switch (Nikiforos and Foley, 2012; Palley, 2014a; Nikiforos, 2016). Some empirical contributions support the hypothesis that there are differences between the short- and the long-run effects of a change in the wage share (Stockhammer and Stehrer, 2011; Kiefer and Rada, 2015; Barrales and von Arnim, 2017). 2 Second, another recent strand of the Post-Keynesian literature goes beyond the functional income distribution when looking into the wage-/profit-led nature of the demand regime. Some contributions soften the dichotomy between workers and capitalists and distinguish between three classes or allow for capitalists-managers to receive a certain part of wage income (Lavoie, 2009; Palley, 2014b). Others include the personal into the functional income distribution (Tavani and Vasudevan, 2014; Carvalho and Rezai, 2016; Palley, 2017a). Personal income inequality (typically understood as wage inequality) affects the degree to which an economy is wage- or profit-led, and opens up the possibility of regime switches through changes in its (usually exogenously given) distribution. A third strand of the literature includes financial variables in the Bhaduri-Marglin model. The bulk of these contributions focuses on household and business debt and their redistributive and demand effects (Palley, 1994; Dutt, 2006; Hein, 2012). Some others, however, additionally include asset prices and often use them as a synonym for wealth, albeit without investigating their distribution (Bhaduri, 2011). Empirically, Stockhammer and Wildauer (2016) find that these financial variables impact aggregate demand. From a different Post-Keynesian angle, a small but growing strand of the literature models wealth and the wealth distribution in an analytical setting, building on the insights of Pasinetti 2 See Blecker (2016) for a discussion. 5/23 (1962). In particular, contributions by Dutt (1990), Palley (2012, 2017b), Taylor et al. (2015) and Ederer and Rehm (2019a, 2019b) include an endogenous wealth distribution into their models and discuss the existence and stability of a long-run equilibrium wealth share. In contrast to the standard Bhaduri and Marglin model and more in the spirit of Pasinetti (1962), these models explicitly distinguish between classes instead of functional income groups. They allow for workers to accumulate wealth and consequently receive profit income, and conversely, for capitalists to earn wage income. They therefore typically include a comprehensive personal income distribution. Ederer and Rehm (2019a, 2019b) furthermore differentiate the wealth compositions of workers and capitalists, which implies differential rates of return on their assets (Ederer et al., 2019). The two contributions most relevant to this paper are Dutt (1990) and Palley (2017b). To the best of our knowledge, these are the only papers analyzing the implications of wealth distribution for the possibility of wage-/profit-led demand. The contribution by Dutt (1990), which precedes the wage-/profit-led debate following Bhaduri and Marglin (1990), discusses the consequences of the wealth distribution in a Kalecki-Steindl model which only allows for wage-led demand. It concludes that a rising profit share unambiguously reduces capacity utilization and increases the wealth concentration. Building on Dutt (1990), Palley (2017b) presents a model which allows for both wage- and profit-led demand and discusses the impact of a change in the wealth distribution on the demand regime. Palley concludes that an increase in the wealth share of workers increases the tendency of the economy to be profitled because a redistribution from wages towards profits would harm consumption less. The discussion is, however, limited to the short-term effect and does not extend to the implications of the endogenous reaction of the wealth distribution to the shift in the profit share for the distribution of profit income and, consequently, for aggregate demand. This is the gap our paper intends to close. This paper contributes to all four of these strands of the Post-Keynesian literature. First, we go beyond the functional and personal income distribution, by explicitly modelling the distribution of wealth. Second, this introduces a new explanation for the difference between short- and long-run effects, and an endogenous potential driver for regime switches. Third, we extend the small but promising literature on wealth inequality in Marglin-Bhaduri models by investigating the implications of an endogenous wealth distribution for the demand regime. 3. The Model The model is a standard two-class, Post-Keynesian formulation in the tradition of Bhaduri and Marglin (1990). It makes the usual assumptions that growth is driven by aggregate demand, and that the profit share is determined by the mark-up of firms over unit labor costs. Drawing on Dutt (1990), Palley (2012, 2017b) and Taylor et al. (2015), and closely following Ederer and Rehm (2019a, 2019b), we introduce four novel aspects with respect to the original Bhaduri- Marglin model: (1) Workers save a certain part of their income; (2) they accumulate wealth 6/23 and are thus entitled to profit income; (3) wage income is split between workers and capitalists; and (4) workers and capitalists have different wealth compositions and thus different rates of return on their assets. We discuss the implications of the first two extensions in this section and turn to the last two in section 5. 3.1 Model definition In the model, income Y is divided between total profits R and the wage bill W according to the (exogenous) functional income distribution 𝜋 (the profit share). 𝑅 =𝜋𝑌 (1) 𝑊 =(1−𝜋)𝑌 (2) We follow Post-Keynesian convention by assuming a positive differential between the saving rates of capitalists 𝑠𝑟 and workers 𝑠𝑤. In the standard Bhaduri-Marglin model, classes and income groups are treated synonymously since workers receive wages and capitalists get all the profit. 3 However, we follow Pasinetti (1962) in distinguishing between classes instead of income groups and allow for workers to save, so that they accumulate wealth and are consequently entitled to profit income. 4 Income of workers (denoted by subscript w) and capitalists (subscript r) thus amount to 𝑌𝑟=𝑧𝑅 (3) 𝑌𝑤=𝑊+(1−𝑧)𝑅 (4) in which z is the shares of capitalists of (productive) wealth, and (1 – z) share of workers: 5 𝑧=𝑉𝑟 𝑉 (5) Both workers and capitalists save a fraction of their income, 𝑆=𝑠𝑤𝑌𝑤+𝑠𝑟𝑌𝑟. In order to detrend income, profits, saving, and investment, we follow convention by normalizing them to the capital stock. This yields: 𝑠= 𝑆 𝐾={𝑠𝑤[(1−𝜋)+(1−𝑧)𝜋]+𝑠𝑟𝑧𝜋}𝑢=[𝑠𝑤+(𝑠𝑟−𝑠𝑤)𝜋𝑧]𝑢 (6) The investment equation is formulated according to the standard Post-Keynesian functional form in the Bhaduri-Marglin tradition, i.e. growth of the capital stock K depends on capacity utilization u and the profit share 𝜋. This allows for both wage- and profit-led demand regimes, depending on the values of the parameters 𝛽1 and 𝛽2 and the saving rates. It is therefore: 3 Since workers do not receive profits in the standard model, it either assumes that workers do not save, or (implicitly) that savings are out of to wage and profit income, but not related to classes (Hein, 2014). 4 In line with the literature, we use the term 'personal income distribution' for the distribution of income between workers and capitalists. 5 If 𝑧 = 1, the model corresponds to the standard Bhaduri-Marglin model. 13/23 However, Equations (11) and (18) show that the downward shift of the ZZ curve is always bigger than that of the IS curve, so that the wealth share unambiguously rises: 11 𝑑𝑧∗∗ 𝑑𝜋 =𝑠𝑤 (𝑠𝑟−𝑠𝑤)𝜋2>0 (19) Capacity utilization unambiguously decreases, so that the economy is wage-led in the longrun; there is no regime switch. However, since the wealth share rises over time, capacity utilization decreases even further in the long run, so that the short-term wage-led effect is strengthened. Thus, regardless of whether the economy is wage-led or profit-led in the shortrun, in the long-run it is always wage-led when we take the (endogenously determined) wealth distribution into account. 12 Figure 4: Wage-led case Source: own elaboration. 11 Another way to show that is to look at the dynamic equation for the wealth share: Since capitalists’ savings (the first term in Equation (13)) react more strongly to a rise in the profit share than their share in total savings (the second term), the wealth share must rise. 12 Note that the long-run equilibrium value for capacity utilization is given by Equation (15). Since it decreases when the profit share rises, the economy is unambiguously wage-led in the long-run. 14/23 5. Extensions 5.1 Model This section extends the basic version presented in the previous section. First, capitalists receive a certain part of wage income, and second, workers and capitalists have different wealth compositions and thus different rates of return on their assets. Both extensions are very well-grounded in the literature. Regarding capitalists’ wage income, several contributions relax the theoretical dichotomy between workers and capitalists or include the personal income distribution into their models (Palley 2014b, Carvalho and Rezai, 2016). Empirically, capitalists receive between 5 and 10% of wages in most Euro-area countries (Ederer and Rehm, 2019a). We thus assume a certain share of wages to go to capitalists, given by an exogenous parameter α. Regarding differential rates of return between workers and capitalists, the Post-Keynesian literature extensively discusses their effects on growth regimes (Kahn, 1959; Laing, 1969; Harcourt, 1972; Pasinetti, 1974, 1983). Possible reasons for differential returns are a more professional wealth management, the ability to take higher risk, a higher likelihood of insider knowledge, and differences in the composition of wealth of workers and capitalists (Ederer and Rehm 2019a). Empirically, the differential in returns amounts to roughly 1.5 percentage points (Ederer et al., 2019), due to workers holding a larger share of their (productive) wealth in low-yield assets, in particular deposits, compared to capitalists. Capitalists thus receive a higher share of profits and benefit more from the compound interest effect. We extend the model by distinguishing between two asset types: deposits, which for simplicity we assume to be non-interest bearing, and profit-generating assets, which yield profit income. Workers and capitalists hold different shares of their wealth in profit-generating assets (𝛾𝑤,𝛾𝑟). Income of workers (denoted by subscript w) and capitalists (subscript r) thus amount to 𝑌𝑤=(1−𝛼)𝑊+ 𝛾𝑤(1−𝑧) 𝛾𝑤(1−𝑧)+𝛾𝑟𝑧𝑅 (20) 𝑌𝑟=𝛼𝑊+𝛾𝑟𝑧 𝛾𝑤(1−𝑧)+𝛾𝑟𝑧𝑅 (21) in which (1 – z) and z are the shares of workers and capitalists of (productive) wealth. The IS curve then becomes: 𝑢∗=𝛽0+𝛽2𝜋 𝑠−𝛽1 (22) 𝑠= 𝑠𝑤[(1−𝛼)(1−𝜋)+𝛾𝑤(1−𝑧) 𝛾𝑤(1−𝑧)+𝛾𝑟𝑧𝜋] +𝑠𝑟[𝛼(1−𝜋)+𝛾𝑟𝑧 𝛾𝑤(1−𝑧)+𝛾𝑟𝑧𝜋] (23) 15/23 Equations (22) and (23) show that the qualitative features of the IS curve are the same as in the basic model. The intercept on the u-axis is positive and capacity utilization decreases when the wealth share rises. The curve is concave and asymptotically approaches a positive value as z approaches infinity. The total saving rate now depends on the share of wage income which accrues to capitalists (𝛼) and the share of profit-generating wealth of workers (𝛾𝑤) and capitalists (𝛾𝑟). A higher 𝛼 increases the saving rate, because capitalists receive a larger share of wage income. It thus shifts the IS curve downward unambiguously, since the increase in the saving rate reduces capacity utilization. Higher 𝛾𝑤 and 𝛾𝑟 reduce and raise the saving rate, respectively, following a redistribution of profit income from workers to capitalists. 13 A higher differential in the rates of return (i.e. a larger difference between 𝛾𝑟 and 𝛾𝑤) thus shifts the IS curve downward. Capacity utilization is still wage-led or profit-led in the short-run as in the basic model, depending on the value of the parameters and the level of the wealth share z. However, 𝛼, 𝛾𝑤, and 𝛾𝑟 now also affect the demand regime. A higher capitalists’ share in wage income increases the tendency of capacity utilization to be profit-led. The higher 𝛼, the smaller is the effect of a redistribution between wages and profits on total savings, since capitalists' saving rate for wage and profit income is the same. Thus, the positive effect of a higher profit share on investment is more likely to dominate the negative impact on consumption. Capitalists' share of wage income affects the sign of the demand regime: an increase in 𝛼 may switch demand from wage-led to profit-led for certain values of z. This result is in line with Palley (2014b) and Carvalho and Rezai (2016). Furthermore, a higher rates of return differential increases the tendency for the economy to be wage-led. A higher share of productive wealth in total wealth of capitalists (or a lower share in workers’ wealth) increases the effect of a redistribution from wages to profits on savings, because it increases (decreases) the share of profits going to capitalists. It is thus more likely that the effect on savings and consumption dominates the opposite effect on investment (which remains unchanged). The ZZ curve now amounts to: 𝑢 = (𝛽0+𝛽2𝜋)𝑧 𝑠𝑟[𝛼(1−𝜋)+𝛾𝑟𝑧 𝛾𝑤+(𝛾𝑟−𝛾𝑤)𝑧𝜋]−𝛽1𝑧 (24) 13 This is only true for 0< 𝑧 <1. At 𝑧 = 0 and 𝑧 = 1, the saving rate is independent from the wealth compositions since the entire profit income goes to workers and capitalists, respectively. 16/23 The main difference to the basic model is that the ZZ curve is not horizontal any more. It passes through the origin 14 and increases with z, as shown in Figure 5. 15 The curve is convex and thus steeper for small values of z and flatter for high values of z. Figure 5: ZZ curve in the extended model Source: own elaboration The distribution of wage income and the wealth compositions now also affect the ZZ curve. A higher 𝛼 shifts the ZZ curve downward because it increases capitalists' savings. For each value of z, a lower capacity utilization is required to maintain the wealth share stable. Its concavity decreases, so that the slope becomes flatter for lower levels of z and the difference between the steeper and the flatter segment of the curve is less pronounced. Consequently, the range of values of the wealth share for which the curve is steep is larger. For small values of 𝛼, the concavity of the curve becomes very pronounced and the steep part at low wealth shares is limited to a small range of z. 16 A higher difference in the wealth compositions shifts the curve downward for 0<𝑧<1, because it increases the share of profits going to capitalists, and thus their savings. Furthermore, it reduces the concavity of the curve, so that it becomes flatter for small values of z and steeper for high values of z. The slope of the flatter part (for higher values of z) positively depends on the difference between the wealth compositions. The long-term equilibrium of the extended model is thus at a lower capacity utilization and at a higher wealth share than in the basic model. Distributing a certain share of wages to 14 Since capitalists also save out of wage income, the only way to force their savings to zero (so that they correspond to the growth of their share in total wealth, which is also zero), is with zero capacity utilization. 15 For a higher wealth share, capacity utilization must increase to raise capitalists' saving so that it corresponds to the increase in their (higher) share of total wealth growth. 16 For 𝛼 =0, the ZZ curve fades into an (almost) linear curve (although with a positive intercept). 1 2 z z u 17/23 capitalists and incorporating differential rates of return shift the wealth distribution in capitalists’ favor, and consequently depress capacity utilization. Furthermore, the extensions have implications for the effects of a shift of the profit share on the ZZ curve. It is now, in contrast to the basic model, not unambiguously downward-shifting any more. For small values of z, it tends to shift upwards and for large values of z downwards, because its concavity increases due to a higher profit share. As with the IS curve, there is a certain threshold 𝑧 for which the ZZ curve shifts upward when the profit share rises if 𝑧<𝑧, and shifts downward if 𝑧>𝑧. The reason is that a higher profit share has a smaller effect on capitalists' savings for low wealth shares, because their share in profit income depends on the level of z. The distribution of wage income and differential rates of return also have an impact on the reaction of the ZZ curve to a shift in the profit share. The larger the value of 𝛼, the higher is the threshold 𝑧, because wage income plays a larger role for capitalists' income. For small values of 𝛼, the threshold may vanish, and the ZZ curve shifts downward unambiguously for 𝑧>0. Likewise, a higher 𝛾𝑤 increases the threshold, while 𝛾𝑟 reduces it. The higher the rates of return differential, the more likely is the ZZ curve to shift downward for a certain value of z. We can thus summarize the discussion by distinguishing between two segments of the ZZ curve: (1) For small values of z, its slope is steep, and the curve shifts upwards when the profit share rises. (2) For larger values, the slope is flat (with its actual slope depending on the difference between the wealth compositions) and the curve shifts downward following an increase in the profit share. The threshold between the two segments of the curve depends on the value of the parameters and may even vanish, so that the curve shifts downward for all z (and its slope is rather flat). The smaller the capitalists’ share in wage income and the higher the rates of return differential, the narrower is the first segment of the ZZ curve. 5.2 Wage-led vs. profit-led in the extended model To investigate the effects of a rise in the profit share on the short- and long-term equilibrium, we distinguish between various cases. First, the IS curve can shift upwards or downwards, according to whether the economy is wage-led or profit-led in the short run. Second, the ZZ curve can possibly shift upwards or downwards (or rather, both curves can have an upward- and downward-shifting segment, as discussed above). Third, the ZZ curve is an increasing function of the wealth share and can possibly have a steep and/or flat slope. It is more likely that the long-run equilibrium is in a steep and upward-shifting segment of the ZZ curve, the lower the level of the wealth share (as it increases the likelihood that it corresponds to a profit-led IS curve). However, for the (rather small) values of 𝛼 usually observed empirically, the zone in which the two both curves exhibit such a behavior becomes narrow. We thus abstract from this case and limit our discussion to the case when the IS curve intersects with the flat and downward-shifting part of the ZZ curve and distinguish between a 18/23 profit-led and a wage-led IS curve (in the short run). The main difference to the basic model is then that the ZZ curve is now upward-sloping instead of horizontal. a) Profit-led: In the profit-led case, the IS curve shifts upward due to a rise in the profit share. In the short run, capacity utilization increases (from (1) to (2) in Figure 6). Since the ZZ curve shifts downward, the economy is no longer in the long-term equilibrium. The wealth share thus increases, and capacity utilization falls, when the economy moves along the IS curve, until it reaches the new long-run equilibrium (from (2) to (3)). Interestingly, since the ZZ curve is now upward-sloping, capacity utilization can be higher or lower than before the increase in the profit share. In the long-run, the economy can thus be either wage- or profit-led, in contrast to the basic model. If the shift of the ZZ curve is large (relative to the shift of the IS curve) and/or the slope of the ZZ curve is flat (or the slope of the IS curve is steep), the economy ends up at a lower capacity utilization, and the long-run demand effect is wage-led. In the opposite case, it is still profit-led, although the (positive) long-term demand effect of the rising profit share is smaller than the short-term effect because the rising wealth share reduces capacity utilization (ceteris paribus). Figure 6: Profit-led case in the extended model Source: Own elaboration. b) Wage-led: If the IS curve shifts downward when the profit share rises, then capacity utilization is wageled in the short-run. The economy moves from (1) to (2) in Figure 7. Since the ZZ curve also shifts downward, the new long-run equilibrium is at a lower level of capacity utilization. As 19/23 with the basic model, the ZZ curve may shift either more or less than the IS curve, with similar implications for capacity utilization and the wealth share. However, as before, capitalists’ savings are more sensitive to a change in the profit share than their share in total savings, so that the wealth share increases, and capacity utilization decreases further. In the long run, the (short-run) wage-led effect is reinforced by the rise in the wealth share. The difference between the long-run and short-run effect, however, is less pronounced than in the basic model since the ZZ curve is now upwards sloping. Figure 7: Wage-led case in the extended model Source: Own elaboration. 6. Conclusion The paper investigates whether the distribution of wealth affects the demand effects of a shift in the functional income distribution. We construct a Post-Keynesian model in the tradition of Bhaduri and Marglin (1990) and include an endogenous wealth distribution, as well as the distribution of wage income and different wealth compositions between workers and capitalists. We find that whether capacity utilization responds positively (profit-led) or negatively (wage-led) to a redistribution towards profits depends on the wealth share: the higher the concentration of wealth in the hands of capitalists, the lower is aggregate demand and capacity utilization. Furthermore, the distribution of wealth adjusts endogenously to a shift in the functional income distribution in the long run. With a rising profit share, capitalists’ wealth share increases, because their savings react more strongly than workers’. In other words, a higher 20/23 wealth share of capitalists implies a higher saving rate, and as a consequence, capacity utilization declines. Depending on whether the economy is wage-led or profit-led in the short-run, there are a number of possible cases: In the profit-led case, the short-run effect of a rise in the profit share on capacity utilization is positive. Following the endogenous increase of the wealth share, capacity utilization falls, so that the long-run effect is smaller than the short-run effect, and there is the possibility of a regime switch. In that case, the short-run profit-led economy becomes wage-led in the long run due to the endogenous effects of wealth inequality. In the wage-led case, the short-run effect of a redistribution towards profits on aggregate demand is negative. In the long run, this effect is intensified, so that capacity utilization falls further. The (negative) long-run effect is thus larger than the short-run effect. This finding has clear policy implications: Even when the demand regime in an economy is profit-led in the short run (i.e., an increase in the profit share stimulates demand), this effect is dampened by the rising wealth concentration and might even become negative over time. If demand, on the other hand, is wage-led, the short-term effect is strengthened by a rising wealth concentration, so that the long-term negative effect on capacity utilization is higher. Incorporating wealth inequality into the analysis thus makes a trade-off between more equality in the functional income distribution and growth less likely. Since this is, to the best of our knowledge, the first attempt of incorporating an endogenous wealth distribution into a demand regime framework, many questions remain open. First and foremost, this paper does not empirically estimate different countries’ demand regimes for reasons of space. 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