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Inequality over the business cycle: the role of distributive shocks

Published online by Cambridge University Press:  18 November 2021

Marius Clemens ,
Ulrich Eydam  and
Maik Heinemann
Marius Clemens*
Affiliation:
DIW Berlin, Mohrenstr. 58, 10117 Berlin
Ulrich Eydam
Affiliation:
University of Potsdam, August-Bebel-Str. 89, 14482 Potsdam
Maik Heinemann
Affiliation:
University of Potsdam, August-Bebel-Str. 89, 14482 Potsdam
*
*Corresponding author: Marius Clemens. Email: mclemens@diw.de
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Abstract

This paper examines how wealth and income inequality dynamics are related to fluctuations in the functional income distribution over the business cycle. In a panel estimation for OECD countries between 1970 and 2016, although inequality is, on average countercyclical and significantly associated with the capital share, one-third of the countries display a pro- or noncyclical relationship. To analyze the observed pattern, we incorporate distributive shocks into an RBC model, where agents are ex ante heterogeneous with respect to wealth and ability. We find that whether wealth and income inequality behave countercyclically or not depends on the elasticity of intertemporal substitution and the persistence of shocks. We match the model to quarterly US data using Bayesian techniques. The parameter estimates point toward a non-monotonic relationship between productivity and inequality fluctuations. On impact, inequality increases in response to TFP shocks but subsequently declines. Furthermore, TFP shocks explain 17% of inequality fluctuations.

Keywords

Business cycleincome and wealth inequalitydistributive shocksD31E25E32
Type
Articles
Information
Macroeconomic Dynamics , Volume 27 , Issue 3 , April 2023 , pp. 571 - 600
Copyright
© The Author(s), 2021. Published by Cambridge University Press

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