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

  • Hong-Ghi Min

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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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
Date of revision:
Handle: RePEc:wbk:wbrwps:2758
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  1. Menzie David Chinn, 1997. "The usual suspects? productivity and demand shocks and Asia-Pacific real exchange rates," Pacific Basin Working Paper Series 97-06, Federal Reserve Bank of San Francisco.
  2. De Gregorio, Jose & Giovannini, Alberto & Wolf, Holger C., 1994. "International evidence on tradables and nontradables inflation," European Economic Review, Elsevier, vol. 38(6), pages 1225-1244, June.
  3. Hamid Faruqee, 1994. "Long-Run Determinants of the Real Exchange Rate: A Stock-Flow Perspective," IMF Working Papers 94/90, International Monetary Fund.
  4. Fischer, Stanley & Easterly, William, 1990. "The Economic of the Government Budget Constraint," World Bank Research Observer, World Bank Group, vol. 5(2), pages 127-42, July.
  5. Persson, Torsten & Tabellini, Guido, 1991. "Is Inequality Harmful for Growth? Theory and Evidence," CEPR Discussion Papers 581, C.E.P.R. Discussion Papers.
  6. Deininger, Klaus & Squire, Lyn, 1996. "A New Data Set Measuring Income Inequality," World Bank Economic Review, World Bank Group, vol. 10(3), pages 565-91, September.
  7. Jocelyn Horne & Paul R. Masson & Jeroen J. M. Kremers, 1993. "Net Foreign Assets and International Adjustment: The United States, Japan, and Germany," IMF Working Papers 93/33, International Monetary Fund.
  8. Alesina, Alberto & Perotti, Roberto, 1996. "Income distribution, political instability, and investment," European Economic Review, Elsevier, vol. 40(6), pages 1203-1228, June.
  9. Robert J. Barro, 1996. "Determinants of Economic Growth: A Cross-Country Empirical Study," NBER Working Papers 5698, National Bureau of Economic Research, Inc.
  10. Bergstrand, Jeffrey H, 1991. "Structural Determinants of Real Exchange Rates and National Price Levels: Some Empirical Evidence," American Economic Review, American Economic Association, vol. 81(1), pages 325-34, March.
  11. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
  12. Alesina, Alberto F & Rodrik, Dani, 1991. "Distributive Politics and Economic Growth," CEPR Discussion Papers 565, C.E.P.R. Discussion Papers.
  13. Vito Tanzi, 1998. "Fundamental Determinants of Inequality and the Role of Government," IMF Working Papers 98/178, International Monetary Fund.
  14. Perotti, Roberto & Alesina, Alberto, 1996. "Income Distribution, Political Instability, and Investment," Scholarly Articles 4553018, Harvard University Department of Economics.
  15. 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.
  16. Adams, Richard H. Jr., 2000. "The politics of economic policy reform in developing countries," Policy Research Working Paper Series 2443, The World Bank.
  17. Agenor, Pierre-Richard, 2002. "Macroeconomic adjustment and the poor : analytical issues and cross-country evidence," Policy Research Working Paper Series 2788, The World Bank.
  18. Strauss, Jack, 1999. "Productivity differentials, the relative price of non-tradables and real exchange rates," Journal of International Money and Finance, Elsevier, vol. 18(3), pages 383-409.
  19. Hsieh, David A., 1982. "The determination of the real exchange rate : The productivity approach," Journal of International Economics, Elsevier, vol. 12(3-4), pages 355-362, May.
  20. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America," MPRA Paper 13843, University Library of Munich, Germany.
  21. Dornbusch, Rudiger, 1974. "Tariffs and nontraded goods," Journal of International Economics, Elsevier, vol. 4(2), pages 177-185, May.
  22. 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, vol. 39(3), pages 771-799, September.
  23. Alesina, Alberto & Tabellini, Guido, 1992. "Positive and normative theories of public debt and inflation in historical perspective," European Economic Review, Elsevier, vol. 36(2-3), pages 337-344, April.
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