Accounting for the Effect of Government Spending on Income Inequality: Role of Markup Dynamics

Abstract

This paper examines the effect of government spending on the markups and income inequality by using a local projection method. We show that markup dynamics play a crucial role in explaining the effect of government spending on income inequality. Our main empirical results are as follows: (i) An increase in government purchases is positively related to the aggregate markup in the developing and closed economies. (ii) Through this positive relationship of markup with fiscal policy, the positive government expenditure shock raises the income inequality in the developing and closed economies. The validity of these results is confirmed by robustness checks.