Human Capital in a Time of Low Real Rates

We argue that a long-term low real rate environment can increase labor income inequality, amplify the emergence of the working rich, and reduce intergenerational mobility. We provide a simple model with endogenous human capital accumulation and credit constraints to demonstrate this causal link. The mechanism operates through a tilting of the human capital gradient: wealthy households, more so than poor households, will increase human capital investment in response to low rates. Normatively, these tilting responses to low rates are inefficient, but higher capital taxes are not an ideal response. We find empirical support for our tilting mechanism over the last 60 years in the U.S. Quantitatively, we show that the endogenous human capital investment response to low interest rates can account for a 17% rise in cross-sectional labor income variance (higher inequality) and a 7% higher parent-child labor income intergenerational elasticity (lower mobility).