This paper develops a political economy model to evaluate how inequality affects policies via the political process. The model is an extension of Krusell and Rios-Rull (1999) to incorporate uninsured idiosyncratic risk to income. Using this framework, we evaluate the response of social insurance policies to rising income inequality. An important feature of dynamic political economy models that incorporate inequality is that policy outcomes affect the evolution of wealth distribution. At the same time, the distribution of wealth affects policy outcomes. These two features make it difficult to solve such models since distribution of wealth is generally a high dimensional object. We tackle this computational problem using the Krusell-Smith (1998) algorithm: we use the mean and the median of the wealth distribution to predict the evolution of prices and political outcomes.
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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number
878.
Length: Date of creation: 03 Dec 2006 Date of revision: Handle: RePEc:red:sed006:878
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Find related papers by JEL classification: E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
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