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Inequality, the price of nontradables, and the real exchange rate : theory and cross-country evidence

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  • Hong-Ghi Min

Abstract

The author provides theoretical and empirical evidence of a negative association between income inequality and real exchange rates. First, he builds a theoretical model showing the transmission mechanism from inequality to real exchange rates. Second, using cross-country data, he demonstrates that the theoretical argument has empirical support. The association is large, significant, and robust to alternative specifications of the reduced form model and estimation methodologies. These findings provide empirical support for Poverty Reduction Strategy Papers, government strategies agreed on with the World Bank that hinge on four major objectives:accelerating equity-based growth, guaranteeing access to basic social services for the poor, expanding opportunities for employment and income-generating activities for the poor, and promoting good governance. The author's analysis indicates that"equity-based growth"and"export-driven growth"are compatible policy goals. But the negative relationship between inequality and real exchange rates does not imply that policies aimed at dramatic redistribution will automatically lead to real depreciation of the domestic currency, improve the external balance, and accelerate economic growth.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2758.

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Date of creation: 31 Jan 2002
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Handle: RePEc:wbk:wbrwps:2758

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Keywords: Payment Systems&Infrastructure; Economic Theory&Research; Fiscal&Monetary Policy; Environmental Economics&Policies; Poverty Impact Evaluation; Macroeconomic Management; Economic Stabilization; Economic Theory&Research; Inequality; Achieving Shared Growth;

References

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  1. Torsten Persson & Guido Tabellini, 1991. "Is Inequality Harmful for Growth? Theory and Evidence," NBER Working Papers 3599, National Bureau of Economic Research, Inc.
  2. Edwards, Sebastian & van Wijnbergen, Sweder, 1987. "Tariffs, The Real Exchange Rate and the Terms of Trade: On Two Popular Propositions in International Economics," Oxford Economic Papers, Oxford University Press, vol. 39(3), pages 458-64, September.
  3. Rodrik, Dani & Alesina, Alberto, 1994. "Distributive Politics and Economic Growth," Scholarly Articles 4551798, Harvard University Department of Economics.
  4. Menzie David Chinn, 1998. "The Usual Suspects? Productivity and Demand Shocks and Asia-Pacific Real Exchange Rates," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 31, Oesterreichische Nationalbank (Austrian Central Bank).
  5. Bergstrand, Jeffrey H, 1991. "Structural Determinants of Real Exchange Rates and National Price Levels: Some Empirical Evidence," American Economic Review, American Economic Association, American Economic Association, vol. 81(1), pages 325-34, March.
  6. Andrea Brandolini & Anthony B. Atkinson, 2001. "Promise and Pitfalls in the Use of "Secondary" Data-Sets: Income Inequality in OECD Countries As a Case Study," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 39(3), pages 771-799, September.
  7. Holger C. Wolf & Alberto Giovannini & Jose De Gregorio, 1994. "International Evidenceon Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
  8. Vito Tanzi, 1998. "Fundamental Determinants of Inequality and the Role of Government," IMF Working Papers 98/178, International Monetary Fund.
  9. Strauss, Jack, 1999. "Productivity differentials, the relative price of non-tradables and real exchange rates," Journal of International Money and Finance, Elsevier, Elsevier, vol. 18(3), pages 383-409.
  10. Alesina, Alberto & Perotti, Roberto, 1996. "Income distribution, political instability, and investment," European Economic Review, Elsevier, Elsevier, vol. 40(6), pages 1203-1228, June.
  11. Robert J. Barro, 1996. "Determinants of Economic Growth: A Cross-Country Empirical Study," NBER Working Papers 5698, National Bureau of Economic Research, Inc.
  12. Masson, Paul R. & Kremers, Jeroen & Horne, Jocelyn, 1994. "Net foreign assets and international adjustment: The United States, Japan and Germany," Journal of International Money and Finance, Elsevier, Elsevier, vol. 13(1), pages 27-40, February.
  13. Hsieh, David A., 1982. "The determination of the real exchange rate : The productivity approach," Journal of International Economics, Elsevier, Elsevier, vol. 12(3-4), pages 355-362, May.
  14. Leonardo Leiderman & Carmen Reinhart & Guillermo Calvo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America," IMF Working Papers 92/62, International Monetary Fund.
  15. Hongyi Li & Lyn Squire & Tao Zhang & Heng-fu Zou, 1999. "A Data Set on Income Distribution," CEMA Working Papers, China Economics and Management Academy, Central University of Finance and Economics 575, China Economics and Management Academy, Central University of Finance and Economics.
  16. Agenor, Pierre-Richard, 2002. "Macroeconomic adjustment and the poor : analytical issues and cross-country evidence," Policy Research Working Paper Series 2788, The World Bank.
  17. Perotti, Roberto & Alesina, Alberto, 1996. "Income Distribution, Political Instability, and Investment," Scholarly Articles 4553018, Harvard University Department of Economics.
  18. Alesina, Alberto & Tabellini, Guido, 1992. "Positive and normative theories of public debt and inflation in historical perspective," European Economic Review, Elsevier, Elsevier, vol. 36(2-3), pages 337-344, April.
  19. Klaus Deininger & Lyn Squire, 1996. "A New Data Set Measuring Income Inequality," CEMA Working Papers, China Economics and Management Academy, Central University of Finance and Economics 512, China Economics and Management Academy, Central University of Finance and Economics.
  20. Dornbusch, Rudiger, 1974. "Tariffs and nontraded goods," Journal of International Economics, Elsevier, Elsevier, vol. 4(2), pages 177-185, May.
  21. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, Elsevier, vol. 42(3-4), pages 327-347, May.
  22. Fischer, Stanley & Easterly, William, 1990. "The Economic of the Government Budget Constraint," World Bank Research Observer, World Bank Group, World Bank Group, vol. 5(2), pages 127-42, July.
  23. Adams, Richard H. Jr., 2000. "The politics of economic policy reform in developing countries," Policy Research Working Paper Series 2443, The World Bank.
  24. Hamid Faruqee, 1994. "Long-Run Determinants of the Real Exchange Rate," IMF Working Papers 94/90, International Monetary Fund.
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