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Sanghamitra Bandyopadhyay and Rui Sun
''How large is the effect of inequality on economic growth?''
( 2021, Vol. 41 No.2 )
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.
Keywords: inequality, growth, vector autoregressions, Bayesian approach.
JEL: O1 - Economic Development: General
C3 - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions
Manuscript Received : Oct 26 2020 Manuscript Accepted : Apr 09 2021

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