Linkage between macroeconomic conditions andinequality in Japan
1

Michio Suzuki2 , Nao Sudo3 and Tomoaki Yamada4

December 26th, 2014

1 Views expressed in this paper are those of the authors and do not necessarily re‡ect

the o¢ cial views of the Bank of Japan.
2 University of Tokyo
3 Bank of Japan
4 Meiji University()

December 26th, 2014

1 / 40Outline of the talk1

Motivation

2Literature3

Direction and Contribution

4

Estimation Methodologies

5Results

6Conclusion(Bank of Japan)

December 26th, 2014

2 / 40Motivation: macroeconomic variables
High growth rates during the 1980s followed by slow down in
the early 1990s.

(Bank of Japan)

December 26th, 2014

3 / 40Motivation: inequality measures
High growth rates during the 1980s followed by slow down in
the early 1990s.

(Bank of Japan)

December 26th, 20144 / 40Motivation: questions we ask in this paper

Do inequalities and macroeconomic variables develop
independently?
If not, what are channels through which inequality andmacroeconomic variables interact?
1

Which component of income reacts di¤erently tomacroeconomic shocks or does asset react di¤erently?

2

Did growing inequality during the 1980s cause bubble boomand subsequent …nancial crisis?

(Bank of Japan)

December 26th, 2014

5 / 402. Literature: from macro to inequality.

Macro shocks to disposable income inequality
1

Skill biased technology change (Acemoglu, 2002)

2

Di¤erence in adjustment for wage or hours (Carpenter and Rogers,2004)

3

Income composition (Coibion et al., 2014)) : pro…t vs earnings.

4

Distributional policy: countercyclical tax or social security system etc.
Macro shocks to consumption inequality

1Di¤erence in asset composition (Saiki and Frost, 2014))

2…nancial segmentation (Coibion et al., 2014)(Bank of Japan)

December 26th, 2014

6 / 402. Literature: from macro to inequality.
1

Krueger et al. (2010) summarize common features of developments
in inequality in nine large countries and document that earnings
inequality appears to be strongly counter-cyclical.

2

Storesletten et al. (2004), using Panel Study on Income Dynamics(PSID), document that the labor market risk is strongly
countercyclical.

3

Coibion et al. (2012) empirically show that a contractionary
monetary policy shock widens earning, disposable income, andconsumption inequality across U.S. households.

4

Saiki and Frost (2014) empirically show that unconventionalmonetary policy has increased income inequality across Japanesehouseholds.

5

Gornemanny et al. (2014) theoretically compare impact oninequality of monetary policy shock with TFP shock, and argue thatthe former shock a¤ect inequality while the latter shock does not.
(Bank of Japan)

December 26th, 2014

7 / 402. Literature: from inequality to macro.
Survey by Ostry, Berg, and Tsangarides (2014).
Inequality foster economic growth.
1Inequality incentivizes harder works (Lazear and Rosen, 1981, Okun,1975).

Inequality dampens economic activity.
1

2

3A severe inequality aggravates health or human capital of poor
(Perotti, 1996; Galor and Moav, 2004; Aghion, Caroli, andGarcia-Penalosa, 1999).
A higher capital share leads rich to invest more on asset, boosts…nancial market, and results in …nancial crisis (Kumof, 2011).
Governmental response by supplying easy credit to poor in a risinginequality leads to …nancial crisis (Rajan, 2010).
(Bank of Japan)

December 26th, 20148 / 402. Literature: from inequality to macro
1Ostry, Berg, and Tsangarides (2014), based on cross-country
analysis, document that lower inequality is correlated with faster andmore durable growth.

2Stiglitz (2013) discusses that inequality fosters …nancial crisis
because people who do not spend much (rich) possess the bulk of
wealth in the economy.

3

Bordo and Meissner (2012), based on cross-country analysis,
document that inequality does not cause …nancial crisis and that a
low interest rate and economic expansion are the only determinants of…nancial crisis.

4Rajan (2010) argues that rising inequality pre-crisis period led topolitical pressure for redistribution that eventually came in the form ofsubsidized housing …nance and …nancial crisis.

(Bank of Japan)

December 26th, 2014

9 / 402. Literature: consumption theory
Disagreement bw income and consumption provides information
about underlying income process.
1

PIH: a permanent component of income a¤ects both income andconsumption while temporary component of income shock a¤ects
income only.

2

Blundell, Pistaferri, Preston (2008) : partial insurance for bothcomponents. Consumption do not respond to permanent income
shock by one-to-one.
Disagreement in how income and consumption inequality reactprovides information about how macro variables a¤ect incomeprocess.

(Bank of Japan)

December 26th, 2014

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3. Direction and Contribution
We investigate linkage between inequality and macroeconomic
variables (i.e., …rst moment or aggregate variables) byformulating VARs.
1
2

3Sample period covers both asset price boom and bust.
Inequality measures include disposable income, income-consumption
covariance, and consumption.
Monthly series.
Our work di¤ers from existing studies in the following aspects.

123Focus: linkage bw inequality and boom-and-bust cycle in Japan.
Type of shocks: broad range of macroeconomic shocks including
policy rate shocks.
Source of change in equality: paying attention to the di¤erent role
played by permanent income component, transitory income
component, or asset.
(Bank of Japan)

December 26th, 201411 / 40

3. Direction and contribution
Some macro variable shock are translated to inequality but
opposite does not necessarily hold.
12

3

Shocks to asset price, iip, and policy rate leads inequality to movecyclically.
Shocks to asset price has played an important role in increasing
consumption inequality during the 1980s.
Macrovariables are barely a¤ected by shocks to inequality measures.

It is likely that transitory income component is not the key
channel of transmission of macroeconomic variables.
12

3

Under a premise that standard consumption theory holds, responses oftransitory income component to macroeconomic shocks are small andinsigni…cant.
Under alternative consumption theory, response of transitory income
component to macroeconomic shocks are insigni…cant.
Shocks to permanent income component or those to asset do seemplay a role in the transmission.
(Bank of Japan)

December 26th, 201412 / 40

Estimation Methodologies

Estimation Methodologies(Bank of Japan)

December 26th, 201413 / 40

Data

1

Data source
the Family Income and Expenditures Survey (hereafter FIES)

2

Sample period
January 1981 to December 2008.
January 1981 to January 1999 for sensitivity analysis.

3

De…nition of inequality
Variance of log of disposable income (yD), covariance of yD and cND,
and that of nondurable consumption (cND). Series are equivalized.
Variance of yL, and other inequality measures, Gini coe¢ cient, 90/50ratio, and 50/10 ratio for sensitivity analysis.

(Bank of Japan)

December 26th, 201414 / 40

Estimation methodology
Benchmark model1

A text book VAR with 5 macro variables; stock price, index ofindustrial production (IIP), in‡ation, unemployment, and policy rate,and 3 inequality measures, log variance of disposable income,covariance of disposable income and consumption, and log variance ofconsumption.
Alternative models used for sensitivity analyses

123

A VAR that consists of factors. Factors are taken from balanced panelthat consists of 81 macroeconomic variables.
Factor augmented VAR similar to Boivin, Giannoni, and Mihov(2009). Factors are taken from balanced panel that consists of 81
macroeconomic variables and 40 inequality variables.
Structural VAR similar to Altig, Christiano, Eichenbaum, and Linde(2006).
(Bank of Japan)

December 26th, 201415 / 40

Results (1)Response of inequality to macro shocks(Bank of Japan)

December 26th, 201416 / 40

Summary of results

Some macro shocks a¤ects inequality in a statisticallysigni…cant manner.
1

A positive shock to stock price and IIP increase inequality indisposable income and consumption and covariance.

2

A positive shock to policy rate decreases inequality in disposable
income and consumption and covariance.

3

These macroeconomic shocks are translated to inequality mainly bya¤ecting variance in permanent income.

4A shock to in‡ation and unemployment do not a¤ect inequality.

(Bank of Japan)

December 26th, 201417 / 40

Summary of results
Shocks to macrovariables are not the dominant but importantshocks to inequality movements.
var yDcov

var cND

Shocks

IIIIIIIIIIIIIIIIII

stockiip
unemploymentin‡ationpolicy ratevarlog yD
cov(yD, cND)
varlog cND

.03
.02
-.00
.01
.01
.17
.01
-.00

-.02
.04
.01
.01
.01
-.03
.02
-.01

.01
.02
.02
.01
.00
-.13
-.00
.03

.03
.02
-.04
.01
.03
.09
-.02
.01

-.05
.01
.02
.01
-.02
-.02
.08
.00

.04
.02
.03
-.02
-.02
-.06
-.08
-.01

.08
.02
-.00
.01
.02
.04
.01
.06

-.05
.02
.02
.02
.00
.01
.01
.06

.03
.02
.02
-.00
.00
-.01
.02
-.07

total

.25

.03

-.03

.14

.05

-.09

.24

.07

.00

where I covers 81-90, II covers 91-00, and III covers 01-80.
(Bank of Japan)

December 26th, 201418 / 40

Response of inequality to macro shocks
Baseline model, Cholesky(Bank of Japan)

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Response of inequality to macro shocks
Baseline model, Generalized impulse(Bank of Japan)

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Response of inequality to macro shocks
Baseline model, Cholesky, sample ends in Jan. 1999

(Bank of Japan)

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Identi…cation using standard consumption theory
Consumption theory provides following identi…cation conditions.
∆var(yD (t )) = var (vP (t )) + var (∆vT (t )) + εyD (t ) ,∆cov(yD (t ) , cND (t ) ) = var (vP (t )) + εyDcND (t ) , and∆var(cND (t ) ) = var (vP (t )) + εcND (t ) or∆var(cND (t ) ) = var (vP (t )) + var (vA (t )) + εcND (t ) or
where vP (t ) and vT (t ) are permanent shock and transitory shock toincome, and εyD (t ), εyDcND (t ) , and εcND (t ) are shocks to variance ofyD , covariance, and variance of cND . vA (t ) is non-income factor thata¤ects consumption inequality such as asset. We further assume vt is notserially correlated.
We estimate how var(vP (t )), var(vT (t )) , and var(vA (t )) react tomacroeconomic shocks.
(Bank of Japan)

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Response of variances to macro shocks
Baseline model, decomposition using standard consumption theory I(Bank of Japan)

December 26th, 2014

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Response of variances to macro shocks
Baseline model, decomposition using standard consumption theory II(Bank of Japan)

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Identi…cation following Blundell, Pistaferri, Preston (2008)
Model of Blundell, Pistaferri, Preston (2008) provides followingidenti…cation conditions.
∆var(yD (t )) = var (vP (t )) + var (∆vT (t )) + εyD (t ) ,∆cov(yD (t ) , cND (t ) ) = φvar (vP (t )) + ψvar (vT (t )) + εyDcND (t ) ,∆var(cND (t ) ) = φ2 var (vP (t )) + ψ2 var (vT (t )) + var (vu (t )where vP (t ) , vT (t ) , vu (t ) is permanent shock to income, transitory
shock to income, and shock to higher moment of income process, andεyD (t ), εyDcND (t ) , and εcND (t ) are shocks to variance of yD , covariance,and variance of cND . We assume vt is not serially correlated.
Following Blundell, Pistaferri, Preston (2008), we further assume thatφ and ψ are 0.6 and 0.06, respectively.
We estimate how var(vP (t )), var(vT (t )) and var(vu (t )) react tomacroeconomic shocks.
(Bank of Japan)

December 26th, 2014

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Response of variances to macro shocks
Baseline model, decomposition following Blundell, Pistaferri, Preston(Bank of Japan)

December 26th, 2014

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Contribution of macroeconomic variables to Inequality
Decomposing varlog yD, baseline model(Bank of Japan)

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Contribution of macroeconomic variables to Inequality
Decomposing cov yDcND, baseline model(Bank of Japan)

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Contribution of macroeconomic variables to Inequality
Decomposing varlog cND, baseline model(Bank of Japan)

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Results (2)Response of macro to inequality shocks(Bank of Japan)

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Summary of results

Inequality shocks do not a¤ect macro variables.
1

Inequality shocks do not a¤ect macroeconomic variables instatistically signi…cant manner in baseline model.

2

Under the alternative model, a positive shock to inequality do nota¤ect macro variables except that it lowers policy rate.
The bulk of variations in macroeconomic variables are
attributed to macro shocks and not to inequality shocks.

(Bank of Japan)

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Response of macro to inequality shocks
Baseline model, Cholesky(Bank of Japan)

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Response of macro to inequality shocks
Baseline model, Generalized Impulse(Bank of Japan)

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Contribution of inequality to macroeconomic variables
Decomposing stock price variations to shocks(Bank of Japan)

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Contribution of inequality to macroeconomic variables
Decomposing IIP variations to shocks(Bank of Japan)

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Contribution of inequality to macroeconomic variables
Decomposing unemployment variations to shocks(Bank of Japan)

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3. Our …ndings:

Shocks to some macroeconomic variables signi…cantly a¤ectinequality.
Shocks to stock, iip, and policy rate a¤ect inequality mainly bychanging variance in permanent income.
Macroeconomic shocks are an important driver of income andconsumption inequality.

Shocks to inequality do not a¤ect macroeconomic variables
signi…cantly.
Inequality shocks are not a important driver of macroeconomic
variables.

(Bank of Japan)

December 26th, 201437 / 40

Thank you(Bank of Japan)

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Response of inequality to FF shock
ACEL(Bank of Japan)

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Response of inequality to FF shock
FAVAR(Bank of Japan)

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