Dynamic and Asymmetric Response of Inequality to Income Volatility: The Case of the United Kingdom

Abstract

Using the quarterly data of the United Kingdom (UK) for the period from 1975Q1 to 2016Q1, the paper analyses the dynamic and the asymmetric responses of inequality to the real gross domestic product (GDP) (income) volatility. For this purpose, we consider the bivariate Generalized Autoregressive Conditional Heteroskedasticity-in-mean (GARCH-M) Structural Vector Autoregressive (VAR) based models to examine the related relationship. Applying this method to the different measures of both income- and consumption inequality (i.e. the measures of the Gini, the standard deviation, and the 90-10 percentile differential), we find that income volatility has an increasing effect on inequality. Not only the real GDP volatility significantly increases inequality, but also its effect is asymmetric. In other words, inequality differently responds to positive and negative income growth volatility shocks. Moreover, the volatility in the GDP-inequality equation tends to amplify the positive dynamic response of inequality to a positive income shock, while diminishing the response of inequality to a negative income shock. The implications of these findings are also drawn.