Income Distribution and the Business Cycle

This thesis consists of six chapters. The first chapter is devoted to the introduction to explore how the income distribution within the countries has become a prominent issue in policy making over time. In the second chapter, the related literature on income distribution, GDP and the relationship between these two variables is reviewed. The methodology used for dating the business cycles is extensively explained in the third chapter. The remaining chapters constitute three self-contained essays. The investigation of a possible relationship between the degree of income equality within the countries, and the severity of recession and expansion phase of business cycles, is examined using two different methods. To carry out the investigation reported in chapters four, five and six we use data collected for 40 years on Gini index values and the GDPs of 36 selected countries. The main goal in the first essay is to determine how the deepness and duration of cycles of GDP is correlated with the Gini index values of countries and whether this relationship is mainly sourced from consumption or investment. Likewise, an investigation is carried out to determine if the number of cycles in consumption, investment and GDP of countries could be associated with the level of income inequality in those countries. The results of the correlation and the t-test analysis indicates that income inequality leads to a deeper and longer decline of GDP, which causes a greater cumulative income loss of GDP during a recession period, and a somewhat faster speed of recovery during an expansion period. In addition, the result of a correlation between Gini index values and the number of cycles in consumption, investment and GDP indicate that income inequality is associated with a greater number of cycles in consumption and GDP and a lower number of cycles in investment. In the second essay, the relationship between income equality and the recession is theoretically examined. Models are presented to show how the movement of four components of GDP as consumption, investment, government spending and net export takes place during a recession period for the countries with different level of income distribution. This shows that the countries with a more equality of income distribution would experience a less costly recession. For empirical analysis the instrumental variable is employed in which the findings of empirical analysis support the theoretical arguments. In the third essay, an instrumental variable analysis is employed to find a possible relationship between income inequality and the intensity of expansionary phase of cycles. Although the signs of the coefficients indicate that a more equal income distribution is associated with a somewhat faster recovery, the results are not statistically significant. Keywords: Income Distribution, Business Cycle, Recession, Expansion, Instrumental Variable, Cumulative Loss and Amplitude