Dynamic Analysis Investigating the long-term

behaviour of Economies
Jrgen Kremer
August 23, 2010
Abstract
This paper presents a procedure for the simulation and analysis of the chrono-
logical development of a macroeconomic model over several time periods, called
dynamic analysis. The models investigated explain a range of crucial observable
macroeconomic eects, such as rising unemployment, falling wages and increas-
ingly unequal wealth distribution. The models also identify a fundamental cause
for these eects: interest rates enhance the imbalance of the wealth distribution
within an economy, and this assertion may even be true if the scal system is
taken into consideration.
Contents
1 Model excluding the state 3
1.1 Households . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2 Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.3 Macroeconomic relations between households and rms . . . . . 4
1.4 Heterogeneous households . . . . . . . . . . . . . . . . . . . . . . 5
1.5 Dynamic Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1.6 Growth rates of total consumption . . . . . . . . . . . . . . . . . 6
1.6.1 Growth of total consumption equals growth of gross na-
tional product . . . . . . . . . . . . . . . . . . . . . . . . 6
1.6.2 Growth in line with growth of income . . . . . . . . . . . 6
1.7 The division of total consumption among household groups . . . 6
1.7.1 Each groups share of consumption is constant . . . . . . 7
1.7.2 Consumption is proportional to the wages of the house-
hold groups . . . . . . . . . . . . . . . . . . . . . . . . . . 7
1.7.3 Consumption of each group is in line with total consump-
tion, but is reduced if income is not sucient . . . . . . . 7
1.7.4 Taking ination into account . . . . . . . . . . . . . . . . 8
1.8 Distribution of wages to household groups . . . . . . . . . . . . . 8
1.8.1 Wages are oriented to the gross domestic product of a group 8
1
1.8.2 Each groups share of wages is constant . . . . . . . . . . 8
1.8.3 Wages are oriented to the household group with the high-
est income . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.9 Determining interest payments and interest income per household
group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
1.10 Closed solution of dynamic analysis without state as economic
actor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
1.10.1 Analysis of wealthy household groups . . . . . . . . . . . 14
1.10.2 Analysis of poor household groups . . . . . . . . . . . . . 15
1.10.3 The case r = 0 . . . . . . . . . . . . . . . . . . . . . . . . 16
1.11 Implementation and results . . . . . . . . . . . . . . . . . . . . . 16
1.11.1 1. Scenario: Interest rate constant 3%, economic growth
constant at 5%. . . . . . . . . . . . . . . . . . . . . . . . . 17
1.11.2 Results of the dynamic analysis: . . . . . . . . . . . . . . 17
1.11.3 Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . 18
1.11.4 2. Scenario: Interest rate constant 3%, economic growth
initially 5% then decreasing to 1.12% after 50 years. . . . 18
1.11.5 Results of the dynamic analysis: . . . . . . . . . . . . . . 18
1.11.6 Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . 19
1.11.7 3. Scenario: Interest rate constant 0%, economic growth
initially 2%, decreasing to 0%. . . . . . . . . . . . . . . . 19
1.11.8 Results of the dynamic analysis: . . . . . . . . . . . . . . 19
1.11.9 Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . 20
1.12 Summary and conclusion . . . . . . . . . . . . . . . . . . . . . . 20
2 The Economic cycle with government 21
2.1 Households . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
2.2 Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.3 State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
2.4 Macroeconomic relations between households, rms and state . . 23
3 Rules for Dynamic Analysis 24
3.1 Specication of income tax and taxes on interest revenues . . . . 24
3.2 Specication of growth and distribution of income and consumption 25
3.3 States share and budget decit . . . . . . . . . . . . . . . . . . . 25
3.4 Interest rate transfer . . . . . . . . . . . . . . . . . . . . . . . . . 26
4 Simulation 27
4.0.1 Initializations for t = 0. . . . . . . . . . . . . . . . . . . . 28
4.0.2 Loop over the years t = 1. . . . . T. . . . . . . . . . . . . . . 29
5 Simulation results of dynamic analysis 31
5.0.3 Scenario 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
5.0.4 Scenario 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
6 Summary and conclusion 36
2
1 Model excluding the state
To begin with we consider a model of a closed economy basically without tak-
ing into account the state as an agent. The corresponding economic cycle is
represented graphically in Figure 1.
Figure 1: Economic cycle excluding the state
1.1 Households
Income from wages \ and interest 1
H
from the saved wealth \ of households
are divided between consumption C and saving o. By denition, the amount
saved is the dierence between the incomes \ +1
H
and expenditure C,
\ +1
H
= C +o. (1)
If o is positive, then \ is increased by the amount of saving. If o is negative,
however, then the saved wealth \ of households is decreased by o.
1.2 Firms
Income of rms consists of yield from sales 1 and of credit 1, that has been
taken on. The symbol 1 is derived from the notion investment. Expenditure
is comprised of wages \ and some part of the nancing costs 1
F
. With 1
F
we denote that portion of the nancing costs that the banks hand over to their
depositors. The remaining dierence of the nancing costs become revenues of
the banks and are therefore integral part of the aggregated income \. Thus,
3
\ includes that portion of the nancing costs of the rms, that are not handed
over to depositors, but that are paid to nancial institutions, that are also rms.
We thus have
1 +1 = \ +1
F
. (2)
A positive amount 1 corresponds to a loan, if 1 is negative, it represents a
repayment of previously received credit.
1.3 Macroeconomic relations between households and rms
From the economic cycle we deduce
1 = C. (3)
The yield from sales by rms corresponds exactly to the expenditure on con-
sumption by households. We simplify reality insofar as we assume, that the rms
sell their products and their services directly to their consumers, that is, to the
households. So, we do not explicitly consider suppliers and distributors. The
rms we model might be interpreted as a virtual aggregation of the companies
that sell to their customers with their suppliers and distributors. Alternatively
we might assume, that the consumer prices are proportionately handed over to
the selling companies and to their suppliers and distributors.
In our nancial systems, expansion of the money supply is realized exclu-
sively via credits of commercial banks. To the contrary, a reduction of the
money supply occurs if loans are paid back or if credits are charged o. This
leads to the fundamental conclusion
o = 1. (4)
Every change of total wealth in the economy by some amount o corresponds to
a change of total debts by an amount 1 of the same size. Thus we also nd,
that total wealth \ equals total debts 1.
We denoted 1
F
to be that portion of the nancing costs that are handed
over to the depositors, so we have
1
F
= 1
H
=: 1. (5)
Note that (5) does not claim, that interest rates on deposits equal base rates.
From (1), (2), (3), (4), and (5) we obtain
\ + 1
H
= C + o
q q q q
\ + 1
F
= 1 + 1.
(6)
The gross domestic product 1 is dened as the sum of all yield by rms or
households or expenditure by rms or households, that is, with (6) and (5) we
derive
1 := C +o = 1 +1 = \ +1. (7)
4
1.4 Heterogeneous households
Hitherto we have not specied households more precisely but treated them as
a homogeneous group. In fact, income and wealth conditions in real economies
are very heterogeneous. We model classes of households which dier in their
wealth, consumption, savings, and income. To do this we think of the economy
as divided into groups of equal numbers of people with equal macroeco-
nomic properties. We use group indices to denote the values of macroeconomic
quantities for household groups. So, \
i
denotes the income of the i-th group,
i = 1. . . . . . The corresponding symbol without indices denotes the aggregated
value, so we have \ =

N
i=1
\
i
.
1.5 Dynamic Analysis
We consider now the annual development of an economy over a period from
today, t = 0, until T years in the future. The relationships presented in the
previous sections hold for every year t = 0. . . . . T. We characterize all the
quantities that appear through a time index t. Thus, we denote \
i
t
to be the
income of group i in year t, and dene \
t
=

N
i=1
\
i
t
.
We assume that for each group i = 1. . . . . some initial wealth \
i
1
is
specied for year t = 1. With r
t
we denote the annual risk free rate for the
time interval from t 1 to t. We model economic growth with growth factors
n
t
for the years t = 1. . . . . T by
1
t
= (1 +n
t
) 1
t1
.
We use the representation 1
t
= \
t
+ 1
t
for the gross domestic product. 1
t
denotes total interest payments on wealth, i.e., 1
t
= r
t
\
t1
, where \
t1
is
aggregated wealth in year t 1. Thus, total income of the economy is given by
\
t
= 1
t
r
t
\
t1
.
\
t
is to be distributed among the household group. For t = 0 we specify an
initial income distribution \
1
0
. . . . . \
N
0
, and for later years t 0 we dene
factors c
i
t
0 based on rules to be explained later with

N
i=1
c
i
t
= 1 so that
\
i
t
:= c
i
t
\
t
.
Thus, for each year t we have

N
i=1
\
i
t
= \
t
. We further assume that overall
consumption changes with certain growth rates c
t
, t = 1. . . . . T, so that we have
C
t
= (1 +c
t
) C
t1
.
Further, individual household groups have to contribute to overall consumption
C
t
for t = 1. . . . . T. For this we dene, corresponding to wages, an initial
distribution C
1
0
. . . . . C
N
0
of consumption and for t 0 factors
i
t
0 with

N
i=1

i
t
= 1, so that
C
i
t
:=
i
t
C
t
.
5
Again we nd

N
i=1
C
i
t
= C
t
. Furthermore the amount of saving per household
group is calculated,
o
i
t
= \
i
t
+1
i
t
C
i
t
.
Finally the amounts of wealth in year t work out as
\
i
t
= \
i
t1
+o
i
t
.
This procedure is now iterated over time. The simulation is terminated when
either the nal year T is reached or when the overall income in the economy
\
t
= 0. In the latter case the share of interest in the gross domestic product
reaches 100%.
Besides the presetting of initial data, the algorithm requires exactly three
rules. We need to specify
the growth rates c
t
of total consumption C
t
,
the distribution factors c
i
t
for total wages \
t
,
and the distribution factors
i
t
for total consumption C
t
.
1.6 Growth rates of total consumption
We assume an initial distribution C
1
0
. . . . . C
N
0
of consumption and thus total
initial consumption C
0
as given and specify two rules to dene factors c
t
, t =
1. . . . . T, so that
C
t
= (1 +c
t
) C
t1
.
1.6.1 Growth of total consumption equals growth of gross national
product
We assume that consumption has the same growth as the overall economy. Thus,
with c
t
:= n
t
we model C
t
= (1 +n
t
) C
t1
. This approach might overestimate
the growth of total consumption if economic growth is caused in larger parts by
the growth of interest payments.
1.6.2 Growth in line with growth of income
Here we assume that the relative change of income is reected in relative change
of consumption,
Ct
Ct1
=
Wt
Wt1
. We thus model c
t
:=
Wt
Wt1
1. If the total
wages are reduced substantially by interest payments, then this approach might
underestimate the growth of total consumption.
1.7 The division of total consumption among household
groups
We need a rule to distribute total consumption C
t
among the household groups,
C
i
t
=
i
t
C
t
. For t = 0 consumption for each group is given in advance, so we
have
i
0
=
C
i
0
C0
for each i.
6
1.7.1 Each groups share of consumption is constant
Here we dene
i
t
=
i
0
:=
C
i
0
C0
for all t and for each group i. Thus, in this case
we have C
i
t
=
i
0
C
t
.
1.7.2 Consumption is proportional to the wages of the household
groups
Here we dene for t = 1. . . . . T the distribution factors
i
t
of the i-th group by

i
t
:=
W
i
t1
Wt1
. Thus, a groups share of wages in the previous period determines its
share of consumption for the current period. One problem with this approach
is, that it lets consumption of a group shrink to zero, if the income of this group
vanishes.
1.7.3 Consumption of each group is in line with total consumption,
but is reduced if income is not sucient
We model that household groups will reduce their consumption to a certain
extent if their income dont suce. We have to take into account that the
households cannot cut down on their consumption completely. So we dene for
each group i and for each point in time t a target consumption
~
C
i
t
, that we call
projected consumption, and that evolves in accordance with the growth rates
of total consumption. Thus, if we denote these preliminary growth rates with
~ c
t
, we have
~
C
i
0
: = C
i
0
.
~
C
i
t
: = (1 + ~ c
t
)
~
C
i
t1
for t = 1. . . . . T and for i = 1. . . . . . Now we x a year t. At rst we check for
each group i whether the income of this group suces to nance its consump-
tion. If this is the case we dene the projected consumption to be the actual
consumption, C
i
t
:=
~
C
i
t
. If the projected consumption cannot be nanced we de-
ne C
i
t
:= \
i
t
, if \
i
t
c
C
~
C
i
t
for some given constant 0 c
C
1, which we call
consumption barrier. Finally, for the case \
i
t
< c
C
~
C
i
t
we dene C
i
t
:= c
C
~
C
i
t
.
If we set c
C
= 70%, for example, this means, that the households may reduce
their consumption to at most 70% of their projected consumption before they
run into debts. In summary we dene
C
i
t
:=

~
C
i
t
if
~
C
i
t
\
i
t
\
i
t
if c
C
~
C
i
t
\
i
t
<
~
C
i
t
c
C
~
C
i
t
if \
i
t
< c
C
~
C
i
t
.
Of course, we have C
t
=

N
i=1
C
i
t
for the realized total consumption, and we
compute the corresponding growth rate c
t
as c
t
:=
Ct
Ct1
1. Finally, we set

i
t
:=
C
i
t
Ct
for each group i.
7
1.7.4 Taking ination into account
In the preceding sections we dened rules for the denition of consumption
growth rates ~ c
t
, and we linked the growth of total consumption to the growth of
gross national product or to the growth of total income. We interpret ination
as additional growth of prices, that is reected in additional growth of projected
consumption. Thus, if we denote r
inf
t
to be the ination rate, we dene projected
consumption as
~
C
i
0
: = C
i
0
.
~
C
i
t
: =

1 +r
inf
t

(1 + ~ c
t
)
~
C
i
t1
.
In the sequel, we occasionally use the notation
n = n (r
1
. . . . . r
n
)
to express that a quantity n is dependent on parameters r
1
. . . . . r
n
. Thus,
the dependencies of consumption C
i
t
of the i-th group in year t on its pa-
rameters may be written symbolically as C
i
t
= C
i
t

~
C
i
t
. \
i
t
. \
i
t1
. r
t
. c
C

=
C
i
t

~
C
i
t1
. ~ c
t
. r
inf
t
. \
i
t
. \
i
t1
. r
t
. c
C

.
1.8 Distribution of wages to household groups
For the distribution of wages \
t
to the wages \
i
t
of household groups, \
i
t
=
c
i
t
\
t
, we present several variations in the model. For t = 0 wages are given in
advance, so we have c
i
0
=
W
i
0
W0
for i = 1. . . . . .
1.8.1 Wages are oriented to the gross domestic product of a group
Here we assume that the wages of the i-th group are distributed in proportion
to the share of that group in the gross domestic product. We dene, for t =
1. . . . . T, c
i
t
:=
Y
i
t1
Yt1
, where 1
i
t
:= \
i
t
+1
i
t
.
1.8.2 Each groups share of wages is constant
We dene
c
i
t
:= c
i
0
:=
\
i
0
\
0
for t = 0. . . . . T. Thus, for each group i we nd \
i
t
= c
i
0
\
t
for all values of t.
1.8.3 Wages are oriented to the household group with the highest
income
In the model this means that the wages of the households with the highest
incomes is linked to the growth of gross domestic product. The incomes of
the remaining groups are adapted so that overall wages are consistent with
8
\
t
= 1
t
1
t
. If 1
t
= 0, then 1
t
= \
t
, and increases in income correspond
exactly to economic growth. If, on the other hand, 1
t
0, then incomes
and their increases are less than the amount of, and the increase in, the gross
domestic product. In this case, incomes cannot rise at an equal rate for all wage
groups.
Not only is this model basically simple, it is also maximally realistic. The
high wage groups participate fully in economic growth, while the income of the
lower wage groups has to make do with what is left over.
First we dene the projected incomes
~
\
i
t
:= (1 +n
t
) \
i
t1
for i = 1. . . . . . We assume that household groups are numbered in ascending
order by income, so that the -th group has the highest income. As the sim-
ulation is terminated when \
t
0, we can always assume that \
t
0. We
consider the following dierent cases:
1
st
Case We assume
N

i=1
~
\
i
t
\
t
.
In this case the available total wage \
t
exceeds the projected total wage

N
i=1
~
\
i
t
,
so that \
t
can be distributed proportionally to the projected wages
~
\
i
t
of each
household group. Therefore we dene
c
i
t
:=
~
\
i
t

N
i=1
~
\
i
t
=
\
i
t1

N
i=1
\
i
t1
.
In particular here we have 0 <
~
\
N
t
< \
t
.
2
nd
Case As with the 1
st
case we assume
0 <
~
\
N
t
< \
t
.
But now we consider the situation
N

i=1
~
\
i
t
\
t
.
Here the projected total wage

N
i=1
~
\
i
t
exceeds the available amount \
t
. To
reduce the wages of the lower groups i < to an amount below their projected
values
~
\
i
t
we look for a parameter ` 0, so that
\
t
= c
(N1)
~
\
1
t
+ +c

~
\
N1
t
+
~
\
N
t
= c
N
N

i=1
c
i
~
\
i
t
.
9
The greater factor ` is, the more strongly incomes for wage groups < decrease.
With the following proof we demonstrate both the existence and the uniqueness
of this parameter `.
Theorem 1 Assume values 0
~
\
1
t

~
\
N
t
and \
t
with the properties
0 <
~
\
N
t
< \
t
(8)
and
N

i=1
~
\
i
t
\
t
. (9)
Then there is a uniquely determined parameter ` such that
\
t
= c
N
N

i=1
c
i
~
\
i
t
.
Proof. We look at the polynomial
1 (r) := r
N1
~
\
1
t
+ +r
~
\
N1
t
+

~
\
N
t
\
t

.
For r = 0 we have 1 (0) =
~
\
N
t
\
t
< 0. From (8) and (9) we conclude
~
\
N1
t
0, and for n :=
Wt
~
W
N
t
~
W
N1
t
0 we obtain
1 (n) = n
N1
~
\
1
t
+ +n
2
~
\
N2
t
0.
Thus, by the intermediate value theorem, 1 has as a root r
0
2 (0. n]. Further
we have
1
0
(r) = ( 1) r
N2
~
\
1
t
+ + 2r
~
\
N2
t
+
~
\
N1
t
0
for all r 0, and 1 is strictly increasing. Thus the root r
0
is uniquely deter-
mined. Finally we determine `
0
by the condition r
0
= c
0
, and the theorem
is proved.
The root of 1 can be calculated by a standard method, such as the Newton
algorithm. A natural initial value is
r :=
\
t

~
\
N
t
~
\
N1
t
=
1
(1+yt)
\
t
\
N
t
\
N1
t
.
If the root r
0
= c
0
is found, then we have
\
t
=
N

i=1
c
0(Ni)
~
\
i
t
=
N

i=1

c
0(Ni)
(1 +n
t
)
\
i
t1
\
t

\
t
.
10
Thus if we dene
c
i
t
:= c
0(Ni)
(1 +n
t
)
\
i
t1
\
t
= c
0(Ni)
~
\
i
t
\
t
and
\
i
t
:= c
i
t
\
t
.
we obtain
\
t
=
N

i=1
c
i
t
\
t
=
N

i=1
\
i
t
.
The c
i
t
thereby dene the desired distribution of overall income \
t
of the econ-
omy to individual household groups.
3
rd
Case
0 < \
t

~
\
N
t
.
Here the income \
t
to be distributed is less than the amount
~
\
N
t
which is
to be allocated to the group with the highest income on the basis of economic
growth. In this case we dene
\
N
t
:= \
t
and
\
1
t
:= := \
N1
t
:= 0.
This therefore means that c
N
t
= 1 and c
1
t
= = c
N1
t
= 0. In this case, then,
we allocate the entire available income \
t
to the highest income group.
1.9 Determining interest payments and interest income
per household group
If we divide interest into percentages of consumption among households, we
obtain as the interest payment hidden in consumption j
i
t
of the i-th household
j
i
t
:=
C
i
t
C
t
1
t
=
i
t
1
t
.
We dene the balance 7
i
t
of interest income 1
i
t
and interest payments j
i
t
of the
i-th household as
7
i
t
:= 1
i
t
j
i
t
. (10)
Obviously, we have
N

i=1
7
i
t
=
N

i=1
1
i
t

1
t
C
t
N

i=1
C
i
t
= 0.
11
1.10 Closed solution of dynamic analysis without state as
economic actor
We look at dynamic analysis without state for the special case of constant in-
terest rates r
t
= r and for constant economic growth n
t
= n. Further we assume
time independent distributions of total income \
t
and of total consumption C
t
,
\
i
t
= c
i
\
t
C
i
t
=
i
C
t
with constant factors 0 c
i
1,

N
i=1
c
i
= 1, and 0
i
1,

N
i=1

i
= 1,
for i = 1. . . . . . With o
0
= 1
0
C
0
we nd
o
t
= 1
t
C
t
= (1 +n)
t
o
0
.
where we have assumed, that consumption grows with economic growth, so that
c
t
= n. With \
t
= \
t1
+o
t
we nd inductively
\
t
= \
1
+o
0
t

j=0
(1 +n)
j
(11)
= \
1
+o
0
(1 +n)
t+1
1
n
.
The assumption that consumption is in line with economic growth leads to
an evolution of total wealth that is independent of the applied interest rate.
Furthermore, assume o
0
= 1
0
C
0
0. In this case 1
t
grows if and only
if \
t
, and thus total debt, grows. Thus, if accumulation of wealth occurs in
the model economy, then economic growth and increasing indebtedness always
occur simultaneously. Using (7) we obtain
\
t
= 1
t
1
t
(12)
= (1 +n)
t
1
0
r\
t1
= (1 +n)
t
(o
0
+C
0
) r\
1
ro
0
(1 +n)
t
1
n
= r

o
0
n
\
1

+ (1 +n)
t

1
r
n

o
0
+C
0

= +1(1 +n)
t
.
where we dene
:= r

o
0
n
\
1

and
1 :=

1
r
n

o
0
+C
0
.
12
From this we conclude that total income \
t
decreases over time if and only if
1 < 0, that is, if o
0
0 and
r
n
1 +
C
0
o
0
.
Now we investigate the situation for the i-th household group. We have
o
i
t
= \
i
t
+1
i
t
C
i
t
= c
i
\
t
+r\
i
t1

i
C
t
and
\
i
t
= \
i
t1
+o
i
t
.
From this we derive the recursion
\
i
t
=

c
i
\
t

i
C
t

+ (1 +r) \
i
t1
(13)
= c
i
+

c
i
1
i
C
0

(1 +n)
t
+ (1 +r) \
i
t1
=
i
+0
t
1
i
+j\
i
t1
.
where we use the denitions

i
:= c
i
= c
i
r

o
0
n
\
1

.
1
i
:= c
i
1
i
C
0
= c
i

1
r
n

o
0
+

c
i

C
0
.
0 := 1 +n.
j := 1 +r.
With (13) we nd inductively the representation
\
i
t
=

j=0
j
j

i
+

j=0
0
tj
j
j

1
i
+j
t+1
\
i
1
(14)
=

j=0
j
j

i
+1
i

j=0
0
tj
j
j

j=0
j
j

1
i
+j
t+1
\
i
1
=

j=0
j
j

\
i
0
C
i
0

j=0

0
tj
1

j
j

1
i
+j
t+1
\
i
1
=
j
t+1
1
r

\
i
0
C
i
0

j=0

0
tj
1

j
j

1
i
+j
t+1
\
i
1
.
13
where we used

i
+1
i
= c
i

r
n
o
0
r\
1

+c
i

1
r
n

o
0
+

c
i

C
0
= c
i
(o
0
1
0
) +

c
i

C
0
= c
i
(\
0
C
0
) +

c
i

C
0
= c
i
\
0

i
C
0
= \
i
0
C
i
0
.
1.10.1 Analysis of wealthy household groups
For the wealthy groups the relation
i
< c
i
is realistic. Their share of total
consumption is lower than their share of total wages. Therefore we have
c
i
(\
t
C
t
) = c
i
\
t
c
i
C
t
< c
i
\
t

i
C
t
.
With the rst line of (13) we nd
c
i
\
t
= c
i
\
t1
+c
i
o
t
= c
i
(\
t
C
t
) +c
i
\
t1
+c
i
1
t
<

c
i
\
t

i
C
t

+c
i
(1 +r) \
t1
= \
i
t
+c
i
(1 +r) \
t1
(1 +r) \
i
t1
= \
i
t
+ (1 +r)

c
i
\
t1
\
i
t1

.
This leads to the recursion relation
\
i
t
c
i
\
t
(1 +r)

\
i
t1
c
i
\
t1

.
Therefore, if
\
i
1
\
1
c
i
.
then
\
i
t
c
i
\
t
for all t = 0. . . . . T. But the relation
V
i
1
V1
c
i
is indeed conrmed empirically
for the wealthy households; their share of total wealth is at least as large as their
share of total income. With (13) and \
t
= 1
t
1
t
= 1
t
r\
t1
we calculate
\
i
t
=

c
i
\
t

i
C
t

+ (1 +r) \
i
t1
(15)
= \
i
t1
+r\
i
t1
+c
i
1
t
c
i
1
t

i
C
t
= \
i
t1
+r

\
i
t1
c
i
\
t1

+c
i
1
t

i
C
t
.
Furthermore, with 1 = o+C, 1
t
= (1 +n)
t
1
0
and o
t
= (1 +n)
t
o
0
we conclude
c
i
1
t

i
C
t
=

c
i

C
t
+c
i
o
t
= (1 +n)
t

c
i

C
0
+c
i
o
0

0.
14
if c
i

i
. Therefore, if a household group i has the properties
\
i
1
\
1
c
i

i
.
its wealth increases with time, \
i
t
\
i
t1
, for all t = 1. . . . . T.
1.10.2 Analysis of poor household groups
For the poor household groups it is realistic to assume that their share
i
of
total consumption is larger than their share c
i
of total income, so that
i
c
i
.
Therefore, we nd
c
i
(\
t
C
t
) = c
i
\
t
c
i
C
t
c
i
\
t

i
C
t
.
and in analogue to the previous section we have
\
i
t
c
i
\
t
< (1 +r)

\
i
t1
c
i
\
t1

.
So, if
\
i
1
\
1
< c
i
.
then
\
i
t
\
t
< c
i
for all t = 0. . . . . T. Again, we look at the recursion (15), \
i
t
= \
i
t1
+
r

\
i
t1
c
i
\
t1

+c
i
1
t

i
C
t
, and calculate
c
i
1
t

i
C
t
= c
i
1
t

i
(1
t
o
t
)
=

c
i

1
t
+
i
o
t
= (1 +n)
t

c
i

1
0
+
i
o
0

.
Thus, if

c
i

1
0
+
i
o
0
0.
that is, if
c
i

i
1
0
o
0
1
0
=
i
C
0
1
0
=
C
i
0
1
0
.
we nd \
i
t
< \
i
t1
for all t = 0. . . . . T. Therefore, if a household group i has the
properties
\
i
1
\
1
< c
i

C
i
0
1
0
<
i
.
its wealth decreases with time.
15
1.10.3 The case r = 0
The special case r = 0 is interesting. In this case in (13) we have
i
= 0 and
1
i
= c
i
(o
0
+C
0
)
i
C
0
= c
i
\
0

i
C
0
= \
i
0
C
i
0
= o
i
0
as well as j = 1. Thus (14) is reduced to
\
i
t
=

j=0
(1 +n)
j

o
i
0
+\
i
1
.
So if for the i-th group the initial incomes \
i
0
exceed initial consumption C
i
0
,
indebtedness will never occur, but this group in the future always partakes in
economic growth.
1.11 Implementation and results
For ease of reading the results of dierent simulations are shown here with
only three household groups. The results are qualitatively the same, though
more striking, if ten groups are considered. In the following tables all monetary
quantities can be interpreted as annual values in units of a thousand euro. The
entries in columns r and n of the growth group are given in percentages, and
the overall growth is a dimensionless factor. We stipulate for each of the
three household groups G1, G2 and G3 the following initial data for income,
consumption and wealth:
Initial data
Group Income Consumption Wealth
G1 20 19 0
G2 30 29 300
G3 50 35 1000
For these initial data we consider the development of the economy under
various assumptions for interest rate and economic growth. The time horizon is
50 years. For ease of reading, only the results for years 0. 10. . . . . 50 are given.
The model calculates the distribution of income to individual households using
the procedure which is oriented to the group with the highest income. The
results are qualitatively the same if other distribution models are considered, in
particular the model that distributes income in proportion to the initial distri-
bution.
In distributing consumption we should note that there are limits on the
extent to which consumption expenditure can be reduced. Food, rent, power
and heating costs have to be paid as well as the cost of childrens education. If
16
prices rise, a reduction in consumption does not necessarily lead to a reduction in
expenditure on consumption. Hence consumption expenditure was distributed
to household groups within the analysis in proportion to the initial distribution.
The following simulations where calculated with consumption barrier c
C
=
100%, but the results do not change qualitatively if we dene a lower bound for
c
C
.
In the tables on the following pages we abbreviate Interest in consumption
to Int. consumption.
1.11.1 1. Scenario: Interest rate constant 3%, economic growth con-
stant at 5%.
The economy has constant interest rates and constant, strong economic growth.
1.11.2 Results of the dynamic analysis:
Years Growth Wealth GDP
r n G1 G2 G3 G1 G2 G3
0 3 5 1.05 1 310 1045 20 39 80
10 3 5 1.71 20 437 1638 34 63 130
20 3 5 2.79 65 633 2602 57 101 212
30 3 5 4.54 158 936 4169 94 162 344
40 3 5 7.39 334 1409 6716 157 262 560
50 3 5 12.04 656 2151 10859 259 423 912
Years Income Consumption Saving
G1 G2 G3 G1 G2 G3 G1 G2 G3
0 20 30 50 19 29 35 1 10 45
10 33 50 83 31 47 57 3 15 73
20 55 82 137 50 77 93 6 24 119
30 90 135 225 82 125 151 12 37 193
40 147 221 368 134 204 246 23 57 314
50 241 361 602 218 333 401 41 90 511
Years Interest income Int. consumption Interest transfer
G1 G2 G3 G1 G2 G3 G1 G2 G3
0 0 9 30 9 14 16 9 5 14
10 1 13 47 14 21 25 13 8 22
20 2 18 74 22 33 40 20 15 35
30 4 27 119 34 53 64 30 26 56
40 9 41 192 55 85 102 46 44 90
50 18 62 310 89 137 165 71 75 146
17
1.11.3 Interpretation
At rst sight the development of the economy appears healthy. Of course, the
saved wealth of all household groups far exceeds the gross domestic product,
that is, the value of all goods and service in the economy. In addition there
is a signicant transfer of interest from the two lower income groups to the
highest. This increases the relative dierences among the wealth development
of households.
1.11.4 2. Scenario: Interest rate constant 3%, economic growth ini-
tially 5% then decreasing to 1.12% after 50 years.
Strong economic growth at the start decreases constantly over time and falls
after 17 years to below 3%, the level of the interest rate.
1.11.5 Results of the dynamic analysis:
Years Growth Wealth GDP
r n G1 G2 G3 G1 G2 G3
0 3 5.0 1.05 1 310 1045 20 39 80
10 3 3.7 1.59 18 432 1622 31 58 122
20 3 2.74 2.17 19 582 2491 37 75 175
30 3 2.03 2.74 57 722 3752 36 88 238
40 3 1.51 3.25 297 791 5536 25 91 315
50 3 1.12 3.69 807 691 8010 0 81 407
Years Income Consumption Saving
G1 G2 G3 G1 G2 G3 G1 G2 G3
0 20 30 50 19 29 35 1 10 45
10 30 45 76 29 44 53 2 14 69
20 37 58 103 39 60 72 2 15 103
30 37 66 130 50 76 91 13 12 147
40 32 67 155 59 90 108 34 1 206
50 22 59 176 67 102 123 67 21 284
Years Interest income Int. consumption Interest transfer
G1 G2 G3 G1 G2 G3 G1 G2 G3
0 0 9 30 9 14 16 9 5 14
10 0 13 47 14 21 25 13 8 21
20 1 17 72 20 31 38 20 14 34
30 1 21 108 29 45 54 31 23 54
40 8 24 160 40 61 74 48 38 86
50 22 21 232 53 81 97 75 59 134
18
1.11.6 Interpretation
The wealth of the lowest income household group begins to fall after 17 years.
Although the economy still continues to grow after 50 years, the wealth of even
the middle household group falls after the 40
th
year. In contrast, the wealth
of the highest income group rises all the more strongly. The gap between the
incomes of the dierent household groups is considerably greater than in the
previous 1
st
scenario, and in the long term the economy becomes unstable.
1.11.7 3. Scenario: Interest rate constant 0%, economic growth ini-
tially 2%, decreasing to 0%.
In this scenario the initial economic growth is reduced from 4% to 2% compared
to the previous scenario, falling further towards zero. The interest rate remains
at zero.
1.11.8 Results of the dynamic analysis:
Years Growth Wealth GDP
r n G1 G2 G3 G1 G2 G3
0 0 2.0 1.02 1 301 1015 20 30 50
10 0 0.6 1.14 12 312 1176 22 33 56
20 0 0.18 1.18 23 323 1347 23 35 58
30 0 0.05 1.19 35 335 1521 23 35 58
40 0 0.02 1.19 46 346 1696 23 35 58
50 0 0.0 1.19 58 358 1871 23 35 58
Years Income Consumption Saving
G1 G2 G3 G1 G2 G3 G1 G2 G3
0 20 30 50 19 29 35 1 1 15
10 22 33 56 21 32 39 1 1 17
20 23 35 58 22 33 40 1 1 17
30 23 35 58 22 34 41 1 1 17
40 23 35 58 22 34 41 1 1 18
50 23 35 58 22 34 41 1 1 18
Years Interest income Int. consumption Interest transfer
G1 G2 G3 G1 G2 G3 G1 G2 G3
0 0 0 0 0 0 0 0 0 0
10 0 0 0 0 0 0 0 0 0
20 0 0 0 0 0 0 0 0 0
30 0 0 0 0 0 0 0 0 0
40 0 0 0 0 0 0 0 0 0
50 0 0 0 0 0 0 0 0 0
19
1.11.9 Interpretation
Even in the case where economic growth is initially slow and nally stagnates,
the economy remains stable in the long term.
1.12 Summary and conclusion
In the model presented here, interest and economic growth are exogenous factors
whose inuence on macroeconomic quantities, such as incomes, consumption,
saving and wealth, is investigated. From the results of this analysis we draw the
following conclusions:
1. The aggregated wealth \ in an economy is exactly equal to the aggregated
debts. The payment of interest on saving capital and the increase in saving
accumulation that this causes lead to a parallel rise in indebtedness and
corresponding interest payments by rms. (o = 1, equation (4)).
2. The simulated economies look well-behaved if indebtedness is low and
economic growth is large.
3. If gross domestic product grows less strongly than the interest part, then
incomes in the economy shrink. In this case a larger part of the gross
national product ows to the owners of capital via interest payments,
while the wages portion falls by a matching amount. That is why eorts
to limit the interest portion of gross domestic product lead to constant
economic growth. (1 = \ +1, equation (7)).
4. If the interest portion of gross domestic product grows, households with
low wage incomes can aord increasingly less consumption, which eventu-
ally leads to indebtedness and can be characterized as impoverishment or
as unemployment. The impoverishment of an increasingly large percentage
of household groups ultimately destabilizes the economy. (Consequence of
2.).
5. Impoverishment of lower household groups can occur even if interest rates
are clearly below economic growth. Therefore economic growth is no guide
for the xing of interest rates. (Closed solution for \
i
t
, equation (14)).
6. Groups with relatively low wealth receive little or no interest income, but
pay so much interest through their consumption that they are net interest
payers. For groups of relatively wealthy households, in contrast, interest
income exceeds interest payments. This group consists of net interest
receivers. Hence a steady stream of interest ows in the economy from net
interest payers to net interest receivers (Interest balance: 7
i
t
= 1
i
t

C
i
t
Ct
1
t
,
equation (10)).
7. The development of income, wealth and consumption over time remains
stable for every household group if interest rate and ination rate in the
20
economy are set at zero. This is particularly true when economic growth
falls or stagnates.
8. But even in the case that interest rates are zero, ination may impoverish
the lower household groups.
Each of these claims is conrmed by the results of the simulation. Assuming
that the model presented here is so comprehensive that the results of dynamic
analysis can be applied to real economies, then we can draw the following con-
clusion: the payment of interest on capital over the long term only lacks desta-
bilizing economic eects if the economy grows constantly and unlimited in time,
i.e. exponentially. In view of the niteness of the earths resources, constant
economic growth is neither desirable nor possible. An economic order which
wishes to remain stable over time must therefore reject the concept of paying
interest on wealth.
The presented models are purely monetary and do not take tangible assets
explicitly into consideration. But because protable assets lead to revenues com-
parable to interest rate payments on monetary wealth, the focus on monetary
wealth is neither misleading nor too restrictive. The models investigated here
do not only explain a range of crucial observable macroeconomic eects, such
as rising unemployment, falling wages and increasingly unequal wealth distri-
bution; they also oer the basis for a solution. When the results are applied
to real economies, the crucial recommendation is that political and economic
structures should be changed so that disequilibrium of wealth is limited within
an economy. In particular, unproductive saving interest and risk-free credit in-
terest enhance the imbalance of the wealth distribution within an economy, and
the results of dynamic analysis allow for the conclusion that the concept of risk
free interest rates is economically false.
There may be a need for improvement in our economies. But if the model
proposed in this article does reect essential features of reality, then no economic
reform can be successful unless the problems caused by the polarization of wealth
in an economy in general and by the payment of interest on wealth in particular
are recognized and solved.
2 The Economic cycle with government
Now we extend the macroeconomic model of the last section by including the
state into the analysis, see Figure 2.
The main new aspect that enters dynamic analysis if we model the state is
the payment of taxes, that results in a redistribution of wealth.
2.1 Households
Households pay taxes T
W
on their gross income \
gross
and they are left with
their net income
\
net
= \
gross
T
W
. (16)
21
Figure 2: The Economic cycle
On their interest income 1
H
they receive on saved wealth \ households pay
capital yields tax T
R
. We aggregate these taxes to the taxes of the households
T
H
= T
W
+T
R
.
The households spend their total income \
gross
+1
H
for consumption C, taxes
T
H
, and saving o,
\
gross
+1
H
= C +T
H
+o. (17)
Some shares of taxes T
H
may be negative and thus constitute subsidies.
2.2 Firms
Income of rms consists of yield from sales 1, from government spending G, and
from credit 1 while expenditure is comprised of gross wages \
gross
, of value
added tax T
F
and of that share of nancing costs 1
F
, that is transferred to the
depositors. The remaining portion of the nancing costs are part of the gross
wages \
gross
. We thus have
1 +G+1 = \
gross
+1
F
+T
F
. (18)
A positive value of 1 denotes the amount that was taken on as credit and a
positive value of 1
F
denotes interest payment on credit. If 1 is negative this
characterizes saving or an amortization of credit.
22
2.3 State
The government raises taxes and pays subsidies. The state receives taxes T
H
from the households and value added tax T
F
from the rms,
T := T
H
+T
F
.
and decides government spending G. If expenditures exceed earnings, a loan
has to be taken on for the dierence 1, that is called budget decit. A positive
value of 1 corresponds to the amount of money for which a loan has to be
taken out. Negative values of 1 lead to a reduction of national debt or even
to government saving. Furthermore interest has to be paid on national debt.
We denote 1
G
to be that portion of the nancing costs, that are handed over
to depositors. The remaining rest of the capital costs are part of government
spending. To sum up we have
1 = G+1
G
T. (19)
2.4 Macroeconomic relations between households, rms
and state
Obviously we always have
1 = C. (20)
sales revenue of the rms equal consumer spending of the households. Further-
more
1 +1 =

\
gross
+1
F
+T
F
1 G

G+1
G
T
H
T
F

(21)
=

\
gross
T
H

1
F
+1
G

1.
We already emphasized, that in our nancial systems every extension of aggre-
gated deposits is performed by taking out loans. Furthermore every reduction
of aggregated deposits is caused by repayment of credits, therefore aggregated
deposits and aggregated debts are mirror images of each other. From this we
conclude
o = 1 +1. (22)
Aggregated savings o thus equal the sum of rms credits 1 and national decit
1. Aggregation over time furthermore leads to the equality of total deposits \
and the sum of total rms debts 1
F
and government debt 1
G
,
\ = 1
F
+1
G
.
The interest earnings of the households are paid by rms and government as
parts of their nancing costs,
1
H
= 1
F
+1
G
=: 1 (23)
23
With (17), (20), (21) and (22) we nd
o = \
gross
T
H
+ 1
H
C
q q q q q
1 +1 = \
gross
T
H
+ 1
F
+1
G
1.
(24)
From diagram (24) we conclude
\
gross
+1
H
T
H
= o +C (25)
= 1 +1 +C
= 1 +1 +1.
We dene the gross domestic product (gdp) 1 as
1 = \
gross
+1
H
T
H
(26)
= \
net
+1
H
T
R
= 1 +1 +C
= o +C.
Thus, gdp may be characterized as the sum of all net-revenues \
gross
+1
H
T
H
of the households in the economy or alternatively as the sum o + C of saving
amounts and consumption expenditures of the households. As in the previous
section, economic growth is dened as growth of gdp.
3 Rules for Dynamic Analysis
3.1 Specication of income tax and taxes on interest rev-
enues
Taxes distribute wealth from the households with large income and wealth to the
other groups. Dynamic analysis permits the investigation of the consequences
of tax and subsidy rates for economies. To this end an income tax rate t
i
may
be specied by the researcher for each household group i = 1. . . . . , a negative
value characterizing a subvention. Thus we calculate income taxes and subsidies
as
T
W i
t
:= t
i
\
gross i
t
.
The net incomes \
net i
t
are dened as
\
net i
t
:= \
gross i
t
T
W i
t
.
We specify taxes for interest revenues compliant to the current regulations in
Germany, that is, for each group we specify an interest tax rate 0
i
t
,
T
R i
t
:= 0
i
t
1
H i
t
.
24
With a constant t
max
0 the factors 0
i
t
are dened as
0
i
t
=

0 if 1
H i
t
0 or t
i
< 0
t
i
if 1
H i
t
0 and 0 t
i
< t
max
t
max
if 1
H i
t
0 and t
i
t
max
.
In Germany, we currently have t
max
= 25%. Thus the interest tax rates 0
i
t
are
functions of t
max
, the income tax rates t
i
and and of the interest revenues 1
H i
t
,
0
i
t
= 0
i
t

1
H i
t
. t
i
. t
max

. By construction, interest tax rates are time dependent

even if income tax rates are not. In the simulation we specify t
max
as variable,
so the researchers may change its value. Obviously the choice t
max
= 0 leads to
vanishing interest revenue taxes. Total taxes for household group i are dened
as
T
H i
t
:= T
W i
t
+T
R i
t
.
3.2 Specication of growth and distribution of income and
consumption
The specications of
the growth rates c
t
of total consumption C
t
,
the distribution factors c
i
t
for total wages \
net
t
,
the distribution factors
i
t
for total consumption C
t
and the consideration of ination
are carried over almost literally to the case where we allow for the government
as an economic actor. But wages \
t
have to be replaced by net wages \
net
t
.
For example, if we calculate interest income 1
H
t
of the households from wealth
\
t1
, we deduce aggregated net income from \
net
t
= 1
t
1
H
t
+ T
R
. This net
income has now to be distributed among the household groups. Furthermore,
for the calculation of consumption C
i
t
for a household group i we use \
net i
t
,
and with A
i
t
:= \
net i
t
+ (1 +r
t
) \
i
t1
T
R i
t
= \
net i
t
+

1 +r
t
0
i
t
r
t

\
i
t1
we dene
C
i
t
:=

~
C
i
t
if
~
C
i
t
A
i
t
A
i
t
if c
C
~
C
i
t
A
i
t
<
~
C
i
t
c
C
~
C
i
t
if A
i
t
< c
C
~
C
i
t
.
where
~
C
i
t
denotes the projected consumption. We occasionally abbreviate this
algorithm with C
i
t
= C
i
t

~
C
i
t
. \
net i
t
. \
i
t1
. r
t
. 0
i
t
. c
C

.
3.3 States share and budget decit
As states share c we dene the share of government expenditure in GDP,
c =
G+1
G
1
(27)
=
1 +T
1
.
25
where we used (19). Thus we have
1 = c1 T. (28)
Values for states share are specied individually by the researcher who carries
out the simulation. From given states share we calculate the budget decit with
(28). Realistic values for states share in the past in Germany are 40%50%.
3.4 Interest rate transfer
We investigate interest income and interest payments for each household group.
Interest income of the i-th group is 1
H i
t
at time t. The rms nance their
capital costs and thus 1
F
t
with their prices. We distribute 1
F
t
proportional to
consumption among the households groups and dene the interest payments j
i
t
hidden in consumption to be
j
i
t
:=
C
i
t
C
t
1
F
t
.
Finally we dene the distribution the depositors share 1
G
of government inter-
est payments on the household groups. With (19) we have G = T + 1 1
G
.
Thus government spending G is reduced by 1
G
. If we assume that government
spending is used to serve public interests, like public health services, schools,
highway construction etc., then we might argue, that a reduction of govern-
ment spending has to be borne by all household groups similarly. If we denote
with
i
t
the reduction of government spending caused by interest payments on
government debt for each group, we are lead to the assumption

i
t
:=
1
G
t

for all i = 1. . . . . . Now we look at the balance 7

i
t
of interest revenues 1
H i
t
and interest payments j
i
t
and
i
t
of the ith household group and nd
7
i
t
: = 1
H i
t
j
i
t

i
t
= 1
H i
t

C
i
t
C
t
1
F
t

1

1
G
t
.
Obviously we have
N

i=1
7
i
t
=
N

i=1

1
H i
t
j
i
t

i
t

=
N

i=1
1
H i
t

1
F
t
C
t
N

i=1
C
i
t
1
G
t
N

i=1
1

= 1
H
t
1
F
t
1
G
t
= 0.
26
because of 1
H
t
= 1
F
t
+ 1
G
t
. If 7
i
t
0, interest income 1
H i
t
exceeds interest
payments hidden in consumption and taxes j
i
t
and
i
t
, and the ith group is net
receiver of interest payments. If 7
i
t
< 0 then interest payments j
i
t
and
i
t
exceed
1
H i
t
, and the ith group net interest payer.
4 Simulation
Again, we assume homogeneous household groups of equal size. Further we
assume that for each group i = 1. . . . . initial data for gross-income, projected
consumption, and wealth are given,
\
gross i
0
.
~
C
i
0
and \
i
1
.
As in the previous section we need the wealth \
i
1
for time point 1 for calcu-
lating interest revenues for time point 0. And again we need for each simulated
year t = 1. . . . . T interest rates r
t
and economic growth factors n
t
for each of
the intervals [t 1. t]. We assume a consumption barrier c
C
that species the
amount of reduction of consumption if the incomes of household groups do not
suce to nance their projected consumption.
Further we prescribe for each group i = 1. . . . . an income tax rate t
i
,
leading to income tax payments
T
W i
t
= t
i
\
gross i
t
.
If t
i
is specied as negative, the amounts T
W i
t
= t
i
\
gross i
t
become negative
and correspond to a subvention for that group. Furthermore, we have to specify
a maximal rate t
max
for the calculation of taxes on interest revenues. This leads
to the denition of the factors 0
i
t
= 0
i
t

1
H i
t
. t
i
. t
max

, and thus we calculate

T
R i
t
= 0
i
t
1
i
t
.
This leads to the total taxes of the households,
T
H i
t
= T
W i
t
+T
R i
t
for each group. For the calculation of value added tax, a corresponding tax
rate t
F
has to be specied. If we want to calculate the budget decit 1, we
have to prescribe a states share c. In this article the tax rates t
i
, t
F
and the
predened states share c are assumed to be time-independent. This restriction
is not necessary for the algorithm, but reduces the amount of data to be specied
by the researcher.
Finally, we assume a percentage value j
G
that represents the initial share of
government debt from total debt, i.e., with 1
1
= \
1
we have
j
G
=
1
G
1
1
1
.
27
The data to be specied in advance for dynamic analysis are collected in the
following table. If a quantity is labeled with group index i or with time index t
it is understood, that this quantity has to be specied for all groups or for all
times, respectively.
Initial data for dynamic analysis
\
gross i
0
gross wages
~
C
i
0
projected consumption
\
i
1
wealth
r
t
interest rates
n
t
economic growth factors
c
C
consumption barrier
t
i
income tax rates
t
max
maximal rate for taxes on capital income
t
F
value added tax rate
c states share
j
G
initial share of government debt from total debt
4.0.1 Initializations for t = 0.
The rst step in dynamic analysis consists in performing several preparing
initial calculations for t = 0. With initial wealth \
i
1
for each group i =
1. . . . . we calculate the initial interest rate revenues of the households, 1
H i
0
=
r\
i
1
. From initial gross wages \
gross i
0
we calculate income taxes T
W i
0
=
t
i
\
gross i
0
and net income \
net i
0
= \
gross i
0
T
W i
0
. Then we calculate
taxes on capital income T
R i
0
= 0
i
0
1
H i
0
and total taxes T
H i
0
= T
W i
0
+ T
R i
0
of the households. The gdp for each household group is 1
i
0
= \
gross i
0
+
1
H i
0
T
H i
0
. From projected consumption
~
C
i
0
we calculate actual consumption
C
i
0
= C
i
0

~
C
i
0
. \
net i
0
. \
i
1
. r
0
. 0
i
0
. c
C

, where we use the consumption barrier

c
C
. This leads to the saving amounts o
i
0
= 1
i
0
C
i
0
for each household group,
and initial wealth is \
i
0
= \
i
1
+o
i
0
. With consumption expenditures we calcu-
late value added taxes, that have to be paid by the rms, T
F i
0
= t
F
C
i
0
, and
decit spending is calculated to be 1
0
= c1
0
T
H
0
T
F
0
, where we use the
given states share c. This determines the credit amounts 1
0
= o
0
1
0
that
have to be taken out by the rms. Total wealth always equals total debts, in
particular 1
1
= \
1
. Initial total debts are distributed with the given value
of j
G
among government and rms, 1
G
1
= j
G
1
1
and 1
F
1
= (1 j
G
) 1
1
.
This leads to government debts and rms debts for t = 0, 1
G
0
= 1
G
1
+1
0
and
1
F
0
= 1
F
1
+ 1
0
. This nally leads to the interest amounts 1
G
0
= r
0
1
G
1
and
1
F
0
= r
0
1
F
1
that pay initial interest income of the households. Government
spending is given by G
0
= 1
0
1
G
0
+T
H
0
+T
F
0
. All initializations are collected
in the following table.
28
Initializations for dynamic analysis
T
W i
0
= t
i
\
gross i
0
income taxes
\
net i
0
= \
gross i
0
T
W i
0
net wages
c
i
0
=
W
net i
0
W
net
0
distribution factors for net wages
1
H i
0
= r\
i
1
interest revenues of the households
0
i
0
= 0
i
0

t
i
. t
max
. 1
H i
0

tax rate for capital income

T
R i
0
= 0
i
0
1
H i
0
taxes on capital income
T
H i
0
= T
W i
0
+T
R i
0
total taxes of the households
1
i
0
= \
gross i
0
+1
H i
0
T
H i
0
gdp
C
i
0
= C
i
0

~
C
i
0
. \
net i
0
. \
i
1
. r
0
. 0
i
0
. c
C

consumption expenditures

i
0
=
C
i
0
C0
distribution factors for consumption
o
i
0
= 1
i
0
C
i
0
saving amounts
\
i
0
= \
i
1
+o
i
0
wealth
T
F i
0
= t
F
C
i
0
value added taxes
1
0
= c1
0
T
H
0
T
F
0
decit spending
1
0
= o
0
1
0
credits of the rms
1
1
= \
1
initial total debt
1
G
1
= j
G
1
1
initial government debt
1
G
0
= 1
G
1
+1
0
government debt for t = 0
1
G
0
= r
0
1
G
1
depositors share of government interest payments
G
0
= 1
0
1
G
0
+T
H
0
+T
F
0
initial government spending
1
F
1
= (1 j
G
) 1
1
initial debts of the rms
1
F
0
= 1
F
1
+1
0
debts of the rms for t = 0
1
F
0
= r
0
1
F
1
depositors share of interest payments of the rms
7
i
0
= 1
H i
0

C
i
0
C0
1
F
0

R
G
0
N
interest rate transfer
4.0.2 Loop over the years t = 1. . . . . T.
We assume, that for year t 1 we have calculated all data for the simula-
tion. From this we calculate all quantities for year t with the following oper-
ations. With the economic growth factor n
t
we determine current gdp, 1
t
=
(1 +n
t
) 1
t1
. Further we calculate the interest rate revenues 1
H i
t
= r
t
\
i
t1
and taxes of capital income T
R i
t
= 0
i
t
1
H i
t
of the households. This leads to
the aggregated net income \
net
t
= 1
t
1
H
t
+T
R
t
of the economy that is to be
distributed with one of the implemented distribution rules among the household
groups, \
net i
t
= c
i
t
\
net
t
. Now we are able to calculate gdp for each group,
1
i
t
= \
net i
t
+1
H i
t
T
R i
t
.
Next we determine gross income \
gross i
t
and income taxes T
W i
t
. To this
end, we use T
W i
t
= t
i
\
gross i
t
and \
gross i
t
= \
net i
t
+T
W i
t
to nd \
gross i
t
=
W
net i
t
1
i
as well as T
W i
t
= \
gross i
t
\
net i
t
. Total taxes for each household
group are T
H i
t
= T
R i
t
+T
W i
t
.
To derive consumption expenditures for some household group, we rst cal-
29
culate projected consumption
~
C
i
t
= (1 + ~ c
t
)
~
C
i
t1
for this group. Then we inves-
tigate, whether projected consumption can be nanced with the income of that
group or whether consumption has to be cut down. Thus we calculate actual
consumption expenditures C
i
t
= C
i
t

~
C
i
t
. \
net i
t
. c
C

for each group. Saving

amounts for each group can now be determined, o
i
t
= 1
i
t
C
i
t
as well as current
wealth \
i
t
= \
i
t1
+o
i
t
.
Value added taxes of the rms are given by T
F
t
= t
F
C
t
because C
t
= 1
t
.
This leads to decit spending 1
t
= c1
t
T
H
t
T
F
t
. Government debt and rms
debts are now calculated to be
1
G
t
= 1
G
t1
+1
t
.
1
t
= o
t
1
t
.
1
F
t
= 1
F
t1
+1
t
.
Depositors shares of the interest rate payments of government and rms are
1
G
t
= r
t
1
G
t1
and 1
F
t
= r
t
1
F
t1
. With T
t
= T
H
t
+ T
F
t
we nally calculate
government spending G
t
= 1
t
1
G
t
+T
t
.
Now we have estimated all quantities for year t to repeat the algorithm for
the next year, if t < T.
All operations are collected in the following table.
30
Time step of dynamic analysis
1
t
= (1 +n
t
) 1
t1
gdp
1
H i
t
= r
t
\
i
t1
interest revenues of the households
0
i
t
= 0
i
t

t
i
. t
max
. 1
H i
t

tax rate for capital income

T
R i
t
= 0
i
t
1
H i
t
taxes on capital revenues
\
net
t
= 1
t
1
H
t
+T
R
t
total net wages
c
i
t
= c
i
t

n
t
. \
net
t
. \
net j
t1

distribution factors for net wages

\
net i
t
= c
i
t
\
net
t
net wages for each household group
1
i
t
= \
net i
t
+1
H i
t
T
R i
t
gdp for each group
\
gross i
t
=
W
net i
t
1
i
gross wages
T
W i
t
= t
j
\
gross i
t
income taxes
T
H i
t
= T
W i
t
+T
R i
t
total taxes of the households
~ c
t
= ~ c
t
(1
t1
) growth of projected consumption
or ~ c
t
= ~ c
t

\
net
t1
. \
net
t

~
C
i
t
= (1 + ~ c
t
)
~
C
i
t1
projected consumption
C
i
t
= C
i
t

~
C
i
t
. \
net i
t
. \
i
t1
. r
t
. 0
i
t
. c
C

consumption expenditures for each group

c
t
=
Ct
Ct1
growth factor of actual consumption

i
t
=
C
i
t
Ct
distribution factors for actual consumption
o
i
t
= 1
i
t
C
i
t
savings
\
i
t
= \
i
t1
+o
i
t
wealth
T
F
t
= t
F
C
t
value added tax
1
t
= c1
t
T
H
t
T
F
t
decit spending
1
G
t
= 1
G
t1
+1
t
government debt
1
G
t
= r
t
1
G
t1
depositors share of government interest payments
G
t
= 1
t
1
G
t
+T
H
t
+T
F
t
government spending
1
t
= o
t
1
t
rms credits
1
F
t
= 1
F
t1
+1
t
rms debts
1
F
t
= r
t
1
F
t1
depositors share of rms interest payments
7
i
t
= 1
H i
t

C
i
t
Ct
1
F
t

R
G
t
N
interest transfer
5 Simulation results of dynamic analysis
From the variety of possible simulations we present just two. We use the initial
data listed in the table below. The unit of the data for gross wages, consumption,
and wealth is 10001nro. The income tax rates are given in unit %. They are
mean rates, not top income tax rates, so a rate of 40% for the 10th group implies
that 40% of gross income of that group is income tax. The rate of 10% for the
rst group is to interpreted as subvention, thus net income of the rst group is
10% higher than its gross income.
31
Household group Gross wages Consumption Wealth Income tax rates [%]
1 10 10 11 10
2 18 18 19 10
3 22 22 49 5
4 26 26 64 3
5 29 27 86 5
6 33 29 119 10
7 38 33 177 15
8 44 37 252 20
9 53 40 464 30
10 76 45 1263 40
5.0.3 Scenario 1
For the rst scenario we assume constant interest rates of 3.5% and constant
economic growth rates of 6%. For these parameters, dynamic analysis leads to
the following results. All calculated data are yearly values, the unit is 10001nro.
Wealth
Year Household group
1 2 3 4 5 6 7 8 9 10
0 11 19 49 64 86 119 177 252 464 1263
10 47 84 118 140 167 213 270 351 606 1707
20 131 234 274 307 336 406 446 523 820 2372
30 309 553 594 648 673 781 769 823 1153 3391
40 664 1192 1225 1317 1321 1490 1357 1345 1676 4991
50 1352 2427 2433 2593 2542 2809 2421 2257 2518 7558
Gross wages
Year Household group
1 2 3 4 5 6 7 8 9 10
0 10 18 22 26 29 33 38 44 53 76
10 20 35 43 51 57 65 75 87 104 150
20 36 65 79 93 104 119 137 158 190 273
30 65 117 143 169 188 214 247 286 344 493
40 117 210 257 304 339 385 444 514 619 887
50 209 377 461 545 607 691 796 922 1110 1592
Net wages
Year Household group
1 2 3 4 5 6 7 8 9 10
0 11 20 23 27 28 30 32 35 37 46
10 22 39 46 53 54 59 64 69 73 90
20 40 71 83 96 99 107 116 126 133 164
30 71 129 150 174 179 193 210 228 241 296
40 128 231 270 313 322 347 377 411 433 532
50 230 415 484 561 577 622 677 737 777 955
32
Consumption expenditures
Year Household group
1 2 3 4 5 6 7 8 9 10
0 10 18 22 26 27 29 33 37 40 45
10 18 32 39 47 48 52 59 66 72 81
20 32 58 71 83 87 93 106 119 128 144
30 57 103 126 149 155 167 190 213 230 258
40 103 185 226 267 278 298 339 381 411 463
50 184 332 405 479 497 534 608 682 737 829
Savings
Year Household group
1 2 3 4 5 6 7 8 9 10
0 1 2 3 3 3 5 5 7 13 43
10 5 9 10 11 11 13 12 13 17 53
20 12 21 21 23 23 26 23 22 26 80
30 24 43 43 46 45 49 42 38 40 123
40 47 85 83 88 85 92 76 66 64 195
50 90 162 158 167 159 171 137 116 104 316
Gdp
Year Household group
1 2 3 4 5 6 7 8 9 10
0 11 20 25 29 30 34 38 44 53 88
10 23 42 49 57 59 65 71 79 89 133
20 44 79 92 106 109 119 129 141 154 224
30 81 146 169 195 200 216 231 250 270 382
40 150 270 310 356 363 391 415 447 475 658
50 275 494 563 646 656 705 745 797 840 1145
Total taxes of the households
Year Household group
1 2 3 4 5 6 7 8 9 10
0 1 2 1 1 1 3 6 9 16 30
10 2 4 2 2 3 7 13 20 36 74
20 4 6 4 3 6 13 23 35 64 129
30 6 12 7 5 11 24 41 63 113 226
40 12 21 13 9 19 43 73 112 200 397
50 21 38 23 16 35 78 131 199 354 700
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Interest transfer
Year Household group
1 2 3 4 5 6 7 8 9 10
0 6 7 6 6 5 5 3 1 6 33
10 9 8 8 8 7 5 4 2 7 43
20 11 10 9 9 8 6 6 4 6 57
30 16 11 11 10 10 7 8 7 3 77
40 23 10 11 10 11 6 12 15 5 104
50 34 6 10 8 11 4 20 28 22 143
The development of the economy seems to be sound and stable. The initial
dierences in wealth are reduced over time due to the scal system. In the rst
years, the disparity of wealth between groups 1 and 10 are of order 100. In later
years, this factor is reduced to 6. While the wealthy 10th group is subsidized
by all other groups, it pays about 50% of total taxes of the households. After
50 years, the 10th group pays 700 TE taxes, whereas the interest transfer this
group receives is far lower, that is 143 TE.
5.0.4 Scenario 2
We choose the same data as in the rst scenario, but we reduce economic growth
to 1%.
Wealth
Year Household group
1 2 3 4 5 6 7 8 9 10
0 11 19 49 64 86 119 177 252 464 1263
10 27 50 84 104 133 180 243 328 588 1674
20 32 63 103 130 172 241 310 412 739 2211
30 20 52 98 132 196 300 379 507 925 2910
40 16 6 57 102 199 354 449 614 1155 3821
50 84 88 33 24 173 400 517 734 1440 5007
Gross wages
Year Household group
1 2 3 4 5 6 7 8 9 10
0 10 18 22 26 29 33 38 44 53 76
10 10 19 23 28 31 36 42 50 61 89
20 10 18 23 28 32 38 45 53 66 98
30 10 18 23 29 33 39 47 57 72 108
40 9 18 23 29 34 41 50 62 79 119
50 10 18 24 30 36 44 54 67 86 132
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Net wages
Year Household group
1 2 3 4 5 6 7 8 9 10
0 11 20 23 27 28 30 32 35 37 46
10 11 21 24 29 30 33 36 40 43 53
20 11 20 24 29 31 34 38 43 46 59
30 11 20 24 29 32 36 40 46 51 65
40 10 20 25 30 33 37 43 49 55 72
50 10 20 25 31 34 39 46 53 60 79
Consumption expenditures
Year Household group
1 2 3 4 5 6 7 8 9 10
0 10 18 22 26 27 29 33 37 40 45
10 11 20 24 29 30 32 36 41 44 50
20 12 22 27 32 33 35 40 45 49 55
30 13 24 30 35 36 39 44 50 54 61
40 15 27 33 39 40 43 49 55 60 67
50 16 30 36 43 44 48 54 61 66 74
Savings
Year Household group
1 2 3 4 5 6 7 8 9 10
0 1 2 3 3 3 5 5 7 13 43
10 1 2 3 3 4 6 7 8 14 46
20 0 0 1 2 3 6 7 9 17 60
30 2 2 2 1 2 6 7 10 20 79
40 5 6 6 5 1 5 7 11 25 102
50 9 12 12 10 4 4 7 13 31 133
Gdp
Year Household group
1 2 3 4 5 6 7 8 9 10
0 11 20 25 29 30 34 38 44 53 88
10 12 22 27 32 34 38 43 49 58 96
20 12 22 28 33 36 41 47 54 65 115
30 11 22 28 34 38 45 51 60 74 139
40 10 20 27 34 39 48 56 66 85 169
50 8 17 24 32 40 52 61 74 97 207
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Total taxes of the households
Year Household group
1 2 3 4 5 6 7 8 9 10
0 1 2 1 1 1 3 6 9 16 30
10 1 2 1 1 2 4 8 12 23 50
20 1 2 1 1 2 5 8 14 26 58
30 1 2 1 1 2 5 9 15 30 68
40 1 2 1 1 2 5 10 17 34 80
50 1 2 1 1 2 6 11 18 38 95
Interest transfer
Year Household group
1 2 3 4 5 6 7 8 9 10
0 6 7 6 6 5 5 3 1 6 33
10 8 9 8 8 7 6 4 1 7 43
20 11 11 10 10 9 7 5 2 8 57
30 14 15 14 14 12 9 7 3 10 76
40 18 20 19 19 16 11 9 5 13 102
50 23 26 26 26 21 14 12 6 17 137
The development of the economy is now dramatically dierent compared
to the rst scenario. After 50 year the rst three groups are indebted. This
could be interpreted as disappearance of the middle class. Instead, the wealth
of the upper groups has increased substantially. The wealth of the 10th group
reaches 5007 TE, whereas in the rst scenario this group achieved 7558 TE,
but in scenario 1 economic growth was much higher than in scenario 2. In the
face of the large dierence of economic growth between the two scenarios, the
dierence of economic wealth seems surprisingly small.
Especially interesting is interest transfer. The subvention of the 10th group
is 137 TE in the 50th year. This is of the same order as the subvention of this
group in the rst scenario, which is 143 TE. But the 10th group now pays only
95 TE taxes, that is this group receives more interest transfer subsidies that it
pays taxes. And we assumed a high mean tax rate of 40%.
6 Summary and conclusion
Through taxes and subsidies the state can carry out a redistribution of wealth
and thereby favour individual household groups. Economic research institutions
point out, that social market economy works well, because the wealthy house-
holds pay most of the taxes. Thus, so researchers and politicians argue, the
redistribution, the social chargeback, from the wealthy to the poor works. This
is true, but it is only one half of the truth. The other half is, that our inter-
est rates based nancial systems have a hidden distribution mechanism from
the large majority of the society to the wealthy minority. The large interest
revenues of this minority are nanced by the rest of society, and this nancing
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might even outbalance the large tax payments of the rich. The concept of in-
terest rates causes a redistribution of wealth in every economy. Each household
group achieves interest payments on savings. On the other hand each group
pays interest on loans that it has obtained. And moreover, what is of utmost
importance, each group pays implicitly interest via consumption and by paying
taxes if we consider government debts. If we apply realistic data and calculate
the dierence between interest earned and interest paid we nd, that in the
second, currently far more realistic scenario, eight from ten household groups
are net payers of interest while two groups are net interest recipients. Therefore
interest rates cause even in the presence of high tax rates for the rich a redistri-
bution of wealth from the household groups with lower wealth to those groups
with large wealth.
The simulation shows that scal systems may redistribute wealth in such
a way, that the development turns out to be stable. But taxes and tax rates
are explicit. They can be measured and they can be communicated. Interest
transfer is a hidden mechanism, that is not even widely accepted by economists
and politicians. And we see, that if we want the taxation system to be capable
of balancing wealth in an economy, tax rates would have to be adjusted subject
to economic growth. We argue, that because interest rates cause massive, but
nevertheless hidden, redistribution of wealth, it is basically an economically
false, at least problematic, concept. If we agree on that, we shouldnt use the
scal system to correct economical errors.
Rising interest costs and levelling o or stagnating economic growth lead to
a reduction in wages. This in turn leads to a reduction in the purchasing power
of the workforce, which nally leads to lower income for rms. The state can
act against this cycle by taking on a part of the debt burden. In this way it can
itself act as a rm and promote employment, wages and consumption potential.
Those, who promote austerity to reduce government debts, should realize that
then others have to be burdened with debts unless total wealth is reduced. This
conclusion is inescapable, because we have credit based nancial systems, so
aggregated wealth equals aggregated debts.
Thus, interventions by the state can lessen for a while the serious negative
symptoms of the economic crisis caused by concentration of wealth that is in
turn caused by the payment of interest. It cannot alter the causes of the crisis.
In the long term state activities end in state bankruptcy, which for example can
lead to currency reform.
If we take tangible assets into account, then we can state more generally,
that one basic reason, probably the basic reason, of the crisis we experience
currently, is the enabling of unlimited concentration of wealth in the hand of
individuals. This leads to the increasing polarization of society we face today
and this will eventually lead to a breakdown of the underlying economy. The
fundamental mechanism that is responsible for this concentration is interest,
interest revenues on nancial capital as well as interest on tangible assets.
The simulation software dynamic analysis was written as Java-applet and
may be used freely for research projects. The author also allows for download
and non commercial use of the Java source code.
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