Department of Economics Working Papers,
Vienna University of Economics and Business, Department of Economics

Abstract: We augment a model of endogenous credit cycles by Matsuyama et al.(2016) with human capital to study the impact of human capital on the stability of central economic aggregates. Thus we offer a linkage between human capital formation and credit market instability on a macrolevel combined with an analysis of functional income distribution. Human capital is modelled as pure external effect of production following a learning-by-producing approach. Agents have access to two different investment projects, which differ substantially in their next generations spillover effects. Some generate pecuniary externalities and technological spillovers through human capital formation whereas others fail to do so and are subject to financial frictions. Due to this endogenous credit cycles occur and a pattern of boom and bust cycles can be observed. We explore the impact of human capital on the stability of the system by numerical simulations which indicate that human capital has an ambiguous effect on the evolution of the output. Depending on the strength of the financial friction and the output share of human capital it either amplifies or mitigates output fluctuations. This analysis shows that human capital is an essential factor for economic stability and sustainable growth as a high human capital share tends to make the system's stability robust against shocks.

Keywords: Human capital, Learning-by-producing, Credit cycles, Financial instability

JEL-codes: C61; E32; E24; J24 August 2017

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