Inequality of nations and endogenous fluctuations in a two country model

The aim of this paper is to investigate the spillover effects through an endogenous world interest rate on the inequality of nations. The model of K. Matsuyama (Econometrica 72 (2004)) is explored under the alternative assumption that the world economy consists of two countries, instead of a continuum of small open economies. The two countries possibly differ in their levels of capital stock and in their population sizes. The spillover effects on capital stock through the world interest rate may cause a poor country and a rich country to diverge. Furthermore, unequal population sizes reinforce the unequal distribution of incomes between the two countries. Interaction of countries with unequal population sizes may also cause endogenous fluctuations.