Business Cycles and Income Inequality: Evidence from Developed and Developing Countries

This study analyses the relationship between business cycles and income inequality for developed and developing countries. The impact of human capital accumulation and redistributive fiscal and monetary policies on income inequality are also evaluated. We applied the SYS-GMM estimation technique to a dynamic panel data and found strong evidence that economic expansion (contraction) leads to decrease (increase) in income inequality for both developed and developing countries and the relationship has become stronger over time for both country groups. The accumulation of human capital (increase in schooling) improves income inequality for both country groups. This relationship has also become stronger over time for both country groups. Interestingly the effects of business cycles and human capital accumulation on income inequality are stronger for developing countries relative to developed countries. Lastly, interest rates and growth in government spending impact significantly on income inequality only for developing countries and the impact has also become stronger over time. These results are robust to various measures of income inequality. The important policy implications of the results are that for developing countries the welfare cost of business cycles can be reduced significantly by using human capital accumulation policies and redistributive fiscal and monetary policies.