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This paper studies the business cycle dynamics of income and wealth distributions in the context of the neoclassical growth model where agents are heterogeneous in initial wealth and non-acquired skills. Our economy admits a representative consumer which enables us to characterize distributive dynamics by the evolution of aggregate quantities. We show that inequality in both wealth and income follow a countercyclical pattern: the former is countercyclical because labor income is more sensitive to the business cycle than capital income, while the latter is countercyclical due to the wealth-distribution effect. We find that the predictions of the model about the income distribution dynamics accord well with the U.S. data.

Income and Wealth Distributions Along the Business Cycle: Implications from the Neoclassical Growth Model