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Income Distribution, Fical Policy and Delays in Stabilization

Perotti, Roberto

In the last two decades the economic policy of several developing countries has often been characterized by perverse cycles of unsustainable policies and attempts at stabilization. A common feature of models designed to show how these delays in stabilizations can be explained in a way that is consistent with individual rationality, is that delays are the result of the interaction of two groups. The present model aims at capturing, in a simple and stylized way, the features of this process. In the model, different coalitions form and change depending on the position of three groups over the degree of redistribution and the timing of debt repayment. The logical structure of the model is very simple. A country is populated by individuals belonging to three different income classes. They must decide, by majority voting, how much of a given external debts to repay in each of two periods. In a representative agent world, exactly half of the debt would be repaid in each period, so as to smooth consumption perfectly over time. This is also the outcome in the economy studied here when the per capita income is high enough, and in a poor economy with an equal distribution of income. In all these cases the position of the "middle class" prevails, and the economy behaves like a representative agent economy, by spreading the cost of the adjustment over the two periods. When the economy is poor and has a highly unequal distribution of income, however, the repayment of the debt is postponed entirely to the second period. Importantly, both the very rich and the very poor agents of this economy have an incentive to postpone stabilization. The paper presents the model, illustrates the solution in the case of no income dispersion, and of a rich and a poor economy, respectively.

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Academic Units
Economics
Publisher
Department of Economics, Columbia University
Series
Department of Economics Discussion Papers, 753
Published Here
March 2, 2011

Notes

October 1995