Income distribution movements and aggregate money illusion

Abstract

The behavior of aggregate demands in an economy is affected by how the distribution of income moves over time. Consider any economy of agents who don't suffer from money illusion, so agents' demand equations are homogeneous in income and prices. This paper describes a property of income distribution movements, called ‘mean scaling’, which is sufficient (and in a weak sense necessary) to make aggregate demands in the economy homogeneous. Mean scaling essentially requires that changes over time in standard income inequality measures (e.g., the coefficient of variation) be independent of changes in mean income over time. An implication is that aggregate demands will not be homogeneous if income redistribution policies are tied to absolute measures of income.