When per capita income is low, increases in income inequality make
macroeconomic cycles less severe. We present a model in which access to credit
is based on earnings potential. If low as well as middle income individuals
are credit constrained, increases in income inequality lead to smaller
fluctuations in aggregate consumption and output. Empirical evidence from
cross-country data supports the view that greater income inequality causes
lower variation of real consumption and output growth in low income countries.
When per capita income is high, however, this effect is reversed.
Full paper (370 KB PDF)
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Last update: July 19, 2001