Income distribution and the business cycle

In ‘Income distribution and the business cycle’, two-class models in the vein of Nicholas Kaldor serve to establish some benchmark results. In a three classes society, the middle class plays an essential role. Contrary to some conventional wisdom, a decrease in inequality might even increase the average propensity to save. Income redistribution during the cycle will affect more the lower and the upper incomes than the middle income class. As income distribution changes in favour of lower (upper) income groups during the downswing (upswing), the behaviour of the middle class will be dominated by a ‘keeping ahead of the Smiths’ attitude in the case of a downswing and by a ‘keeping up with the Joneses’ attitude in the case of an upswing. This is also a signal for the existence of equity aversion as a social preference. In our political economy model of a currency union, there exists a trade-off between unemployment and the concentration of incomes. For governments in a currency union, an optimal strategy is to reduce unemployment to a lower level by election day and to accept a more unequal distribution of incomes. As soon as there are expectations of a more equal distribution, the government loses its majority. During the election period, the government will intend to dampen expectations of a more even income distribution. This is possible by means of a policy of fiscal contraction (such as heavy taxation of leading consumers) that will be associated with rising levels of unemployment. Immediately before the election day, the government distributes its ‘presents’ to leading consumers and thus succeeds in pushing demand and reaching an optimal point for re-election again.