The effect of growth volatility on income inequality☆

a r t i c l e i n f o This paper assesses the long-run effect of growth volatility on income inequality using a comprehensive panel of annual U.S. state-level data during the 1945 to 2004 period. Using the pooled mean group (PMG) estimator, we find evidence supporting the hypothesis that larger growth volatility positively and significantly associates with higher income inequality. Our key finding is robust to alternative lag structures, conditioning variables, inequality measures, volatility indicators, time periods, and panel estimators. Our key finding does change for asymmetric effects, where larger growth volatility positively and significantly associates with higher income inequality only for positive economic growth. The volatility effect proves positive, but insignificant, for negative economic growth. The interrelationships among economic growth, growth volatility, and income distribution (inequality) have generated separate strands in the existing growth literature. One broad strand assesses the effect of growth volatility on economic growth. While conventional wisdom suggests a standard dichotomy in that business cycle volatility and growth are unrelated (Lucas, 1987), other theoretical models predict that growth volatility negatively affects growth The negative effect can occur because higher volatility increases the option value of waiting on investment, lowering growth, whereas the positive effect can occur because households want to consume more today to hedge against the higher volatility (uncertainty) of the future, raising growth. In an influential empirical paper, Ramey and Ramey (1995) use two panels of countries and conclude that economies with higher volatility experience lower growth. Hnatkovska and Loayza (2005) confirm that volatility negatively affects growth and that the negative link largely depends on the country's structural characteristics. Kose et al. (2006) find that the negative relationship between volatility and growth becomes weaker in the 1990s because of trade and financial integration. Imbs (2007) shows that, while volatility negatively affects growth across countries, it positively affects growth across sectors. More recently, Fang and Miller (2014) find a positive volatility effect on growth, using a long sample of U.S. (United States) real gross national product. Another broad strand of research explores the effect of income inequality on growth. argue theoretically that income inequality harms growth through fiscal redistribution and distortion, sociopolitical instability, or imperfect financial markets assert that income inequality exerts a positive effect on growth through incentive, saving rate, or investment indivisibility channels. A similar divide exists at the empirical level: show that income inequality positively affects growth, however. Barro …