Endogenous borrowing constraints and wealth inequality

This paper studies the evolution of wealth inequality in an economy with endogenousborrowing constraints. In the model economy, agents need to borrow to finance humancapital investments but cannot commit to repaying their loans. Creditors can punishdefaulters by banishing them permanently from the credit market. In equilibrium, loandefault is prevented by imposing a borrowing limit tied to the borrower’s inheritance.The heterogeneity in inheritances translates into heterogeneity in the borrowing limits:endogenously, some young borrowers face a zero borrowing limit, some are partlyconstrained, while others are unconstrained. Depending on the initial distribution ofinheritances, it is possible all lineages are attracted to either the zero-borrowing-limitsteady state or to the unconstrained-borrowing steady state — long-run equality. It isalso possible some lineages end up at one steady state and the rest at the other — completepolarization. Interestingly, the wealth dynamics in the model closely resemblethat in the seminal work of Galor and Zeira (1993).