Income Inequality Effects on Real Exchange Rate: Do Differentials between Tails Matter?

Despite the distributive effects of government policies are linked to many macroeconomic variables, the effects on real exchange rate (RER) were relatively neglected. Additionally, estimating the differences between the two tails changes of income inequality in affecting RER has relatively little attention. Theoretically, two main intermediaries for income inequality to affect RER are addressed: economic growth and relative prices of non-traded goods (hereafter denoted by non-tradables) to traded goods (hereafter denoted by tradables). Empirically, the relationship can be positive or negative. In this paper, a dynamic panel model is estimated using macroeconomic data for MENA and North Mediterranean region. The paper proved that inequality is of main determinants of RER. Moreover, both of changes in the right-tail inequality and the left-tail inequality are effectively affecting RER in opposite directions. Also, having different initial income levels between economies lead to differentials in the effects of inequality on RER. All of these require greater cautiousness when dealing with income inequality especially if it is used as a tool to encourage growth and encouraging the competitiveness of domestic products.