Lower Volatility, Higher Inequality: Are They Related?

Abstract

We investigate the relationship between GDP volatility and income inequality to explain the changes in both variables in the last decades of 20(th) century. The theoretical results show that these variables are related to the same parameters of the underlying income microdata. These results are supported by two empirical findings: (i) the simultaneity of the structural breaks in the GDP volatility and income inequality series across five industrialized countries; and (ii) the consistency of the results obtained from decomposing the US GDP volatility and income inequality data with those obtained from the US income microdata. The latter finding explains the diverging trends of the variables during the Great Moderation era. It also finds support for the argument that income inequality gives long-lasting responses to structural economic changes.