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How large is the effect of inequality on economic growth?

Author

Listed:
  • Sanghamitra Bandyopadhyay

    (Queen Mary University of London)

  • Rui Sun

    (London School of Economics)

Abstract

Economists and social scientists have long been interested in understanding the relationship between income inequality and economic growth. While the current empirical literature is inconclusive on the nature of their relationship, we also crucially do not know much about how large the effects of inequality and growth shocks are on each other. In this paper, we use a Bayesian structural vector autoregression approach to estimate the relationship between inequality and GDP growth for two comparable countries, the UK and the USA. We find that that the size of the effects of an inequality shock on growth, and vice versa, are very small, accounting for under 2% of the variance. We also find that the effects of the shocks dissipate within ten years, suggesting that the effects of these shocks are a short-term phenomenon. Inasmuch as the size of the effects of an inequality shock on growth, and a growth shock on inequality are so small, researchers should focus on uncovering macroeconomic mechanisms that govern the inequality-and-growth relationship using multi-equation models.

Suggested Citation

  • Sanghamitra Bandyopadhyay & Rui Sun, 2021. "How large is the effect of inequality on economic growth?," Economics Bulletin, AccessEcon, vol. 41(2), pages 523-531.
    • Handle: RePEc:ebl:ecbull:eb-20-01068
    as

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    References listed on IDEAS

    as
    1. Baumeister, Christiane & Hamilton, James D., 2018. "Inference in structural vector autoregressions when the identifying assumptions are not fully believed: Re-evaluating the role of monetary policy in economic fluctuations," Journal of Monetary Economics, Elsevier, vol. 100(C), pages 48-65.
    2. Daniel Halter & Manuel Oechslin & Josef Zweimüller, 2014. "Inequality and growth: the neglected time dimension," Journal of Economic Growth, Springer, vol. 19(1), pages 81-104, March.
    3. Baumeister, Christiane & Hamilton, James D., 2018. "Inference in structural vector autoregressions when the identifying assumptions are not fully believed: Re-evaluating the role of monetary policy in economic fluctuations," Journal of Monetary Economics, Elsevier, vol. 100(C), pages 48-65.
    4. Alex Cobham & Luke Schlogl & Andy Sumner, 2015. "Inequality and the tails: The Palma proposition and ratio revised," Working Papers 366, ECINEQ, Society for the Study of Economic Inequality.
    5. Banerjee, Abhijit V & Duflo, Esther, 2003. "Inequality and Growth: What Can the Data Say?," Journal of Economic Growth, Springer, vol. 8(3), pages 267-299, September.
    6. Markus Brueckner & Daniel Lederman, 2018. "Inequality and economic growth: the role of initial income," Journal of Economic Growth, Springer, vol. 23(3), pages 341-366, September.
    7. repec:zbw:bofrdp:2018_014 is not listed on IDEAS
    8. Lisardo Erman & Daniel Marcel Kaat, 2019. "Inequality and growth: industry-level evidence," Journal of Economic Growth, Springer, vol. 24(3), pages 283-308, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    inequality; growth; vector autoregressions; Bayesian approach.;
    All these keywords.

    JEL classification:

    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development
    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables

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