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Income Inequality and the Real Exchange Rate

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Author Info
Pablo García
Abstract

In this paper I explore the effect of income inequality on the real exchange rate. I consider a version of the Salter-Swan model, where income inequality affects the real exchange rate through two general equilibrium channels: (i) the aggregation of individual demands derived from non-homothetic preferences; (ii) the workings of Samuelson-Balassa through the effect of inequality on the aggregation of human capital. If demand for non traded goods has an expenditure elasticity greater than one, and if tradables production is relatively intensive in human capital, then inequality has a non-monotonic effect on the level of the real exchange rate. Empirically, I find a strong relationship in levels between inequality and the bilateral real exchange rate. This partial correlation is large, significant, and positive in the case of within estimation and negative in the case of between estimation. I relate this finding to the expected short and long run effects of inequality on the real exchange rate, and the role factor endowments play in real exchange rate determination. I discuss the relationship of this fact with other strands of the literature, like the determinants of inequality, the effect of inequality on growth and the relevance of Samuelson-Balassa.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 54.

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Date of creation: Dec 1999
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Handle: RePEc:chb:bcchwp:54

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  3. Kenneth A. Froot & Kenneth Rogoff, 1996. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Hansen, Julia L. & Formby, John P. & Smith, W. James, 1996. "The Income Elasticity of Demand for Housing: Evidence from Concentration Curves," Journal of Urban Economics, Elsevier, vol. 39(2), pages 173-192, March. [Downloadable!] (restricted)
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  11. Deaton, Angus S & Muellbauer, John, 1980. "An Almost Ideal Demand System," American Economic Review, American Economic Association, vol. 70(3), pages 312-26, June. [Downloadable!] (restricted)
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  16. Bourguignon, F. & Morrisson, C., 1989. "Income Distribution, Development and Foreign Trade: A Cross-Sectional Analysis," DELTA Working Papers 89-05, DELTA (Ecole normale supérieure).
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  17. Giles, David E A & Hampton, Peter, 1985. "An Engel Curve Analysis of Household Expenditure in New Zealand," The Economic Record, The Economic Society of Australia, vol. 61(172), pages 450-62, March.
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  1. Zarzosa Valdivia F.E., 2006. "Income Distribution, Dutch Disease and Real Exchange Rate movements," Working Papers 2006033, University of Antwerp, Faculty of Applied Economics. [Downloadable!]
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