Intertemporal Elasticity of Substitution and the Transitional Dynamics and Steady State of Wealth Distribution

Abstract

In a Ramsey model with heterogeneous individuals, the steady-state equilibrium can form a line in the capital–consumption plane rather than a single point. The paper uses backward induction to study transitional dynamics and the role of heterogeneity in the intertemporal elasticity of substitution. Without heterogeneity in the elasticity, the wealth Gini falls as capital accumulates even while the wealth gap expands. With heterogeneous elasticities, richer distributional dynamics can arise, including U-shaped relationships between income and inequality. Stone–Geary preferences can also generate an inverted-U relationship—the Kuznets curve—because the elasticity changes with wealth.