Income distribution, fiscal policy, and delays in stabilization

Abstract

This paper presents an explanation of the cycles of large fiscal expansions and macroeconomic stabilizations that are frequently observed in developing countries. In the model, different coalitions form and change depending on the position of three groups over the degree of redistribution and the timing of debt repayment. I show that seemingly unsustainable fiscal policies arise from a coalition of the poor and the rich when the distribution of income is highly unequal. When income is distributed more equally, instead, the patterns of fiscal policy and of the trade balance are consistent with the standard predictions of representative agent models. These features of the model seem consistent with available empirical evidence.