Let me begin by noting that I have as yet been unable to obtain a copy and so have not read Piketty's smash hit book yet. However, I think that I know enough about what is in it to post on this particular matter. Anyway, Tyler Cowen at Marginal Revolution has posted a challenge put to him by Tony Smith regarding Piketty's book that can be labeled as coming from the Minnesota Mafia. The econ department at the University of Minnesota, along with the closely allied research department at the Minneapolis Fed, which have long had people going back and forth or simultaneously in both, has long been the real fountainhead of new classical real business cycle DSGE macro, even if some of those who initiated that movement there are either not there anymore (Prescott, and many former students) or no longer a follower of it (Kotcherlakota, now Minneapolis Fed President, although for its failure to predict the crash or say much useful about Fed policy) or both (Sargent). Nevertheless, a major contingent remains in one or both of those places, including Chari, Kehoe, McGrattan, Rios-Bull, and several others, and their former students continue to identify strongly with the place while they are now all over the world.
The centerpiece of post is a paper by Castaneda, Dias-Gimenez, and Rios-Bull (http://www.econ.umn.edu/~vr0j/papers/maxrefin.pdf) entitled, "Accounting for the U.S. Earnings and Wealth Inequality," published in the Journal of Political Economy in 2003. Several other papers are linked, with the most impressive by Heathcote, Storeslettin, and Violante
, an overview paper of the broader approach from 2009.
These models are variations of DSGE models, except that they involve incomplete markets, with Heathcote, et al. calling this approach the "standard incomplete markets"(SIM) approach. The difference from usual DSGE models is what markets are incomplete, in this case idiosyncratic uninsured risks. So, the missing markets are insurance ones, and these are what eventually explains the development of inequality. The other part needed is that there are heterogenous agents done in the Minnesota way, an interval on some variable, in this case discount factors. The main paper also adds a social security mechanism. With proper calibration, they claim to reproduce the pattern of income and wealth inequality in the US economy up to 2003. Most controversially they claim that introducing an estate tax will make little change in wealth distribution, only raising the wealth Gini from .79 to .80. Cowen is impressed.
So, what is going on here? Heathcote et al lay out the various mechanisms and review the broader related literature. Various models have thrown in as shocks family and human capital ones, with the missing insurance markets including finance, public, and some others. There is even a policy claim that being able to separate initial condition effects from later shock effects suggest policies focused on early education to improve human capital or others focused on later "insurance." Obviously this is very different from the reputed story that Piketty ultimately develops regarding dynastic families emerging in a "patrimonial capitalism" and his focus on the overall return to financial capital compared to the overall rate of growth. The stories are extremely different.
In the end, what is really driving Minnesota models is this distribution of different discount factors. So, it is at the bottom line that those on top are patient and willing to abstain while those at the bottom are short-sighted and impatient, tsk tsk. In this view, obviously the losers deserve what they (don't) get, while the virtuous rich deserve theirs. This is the Protestant Ethic triumphant!