Abstract
This paper develops a benchmark stock-flow consistent model that links functional with personal income distribution. The model consists of various household groups that receive income from different sources or from the same sources in different proportions. The dynamic linkage between functional and personal income distribution is formulated as part of a complete macroeconomic system. Inequality decomposition techniques are employed to associate income sources with personal income distribution. Simulation exercises are conducted to reveal the various ways through which functional and personal income distribution interact. In the simulations, a rise in the exogenous component of low-skilled workers’ wage share reduces inequality in the short run; in the medium to long run inequality starts increasing due to certain macroeconomic developments, but remains lower than its initial level in almost all cases. A change in functional income distribution due to a rise in the dividend payout ratio of firms increases inequality both in the short run and the long run.
Highlights
This paper argues that the stock-flow consistent (SFC) approach to macroeconomic modelling can provide the appropriate analytical platform for linking functional with personal income distribution
The absence of an integrated framework that connects functional with personal income distribution constitutes a major gap in modern economic theory
The distinct feature of the suggested platform is the rigorous modelling of the stock-flow interactions in the economy. This permits the formulation of the links between functional and personal income distribution as part of a complete macroeconomic system
Summary
The distribution of income is traditionally a core issue in economic theory and policy analysis. Dagum (1999) puts forward a non-linear income generating function according to which economic units’ income depends on their human capital and wealth Utilising this function as a basis for his analysis, he provides a theoretical framework for the joint examination of functional and personal income distribution. Our SFC model moves beyond Palley’s work in various important ways: it contains more household groups and more income sources; personal income distribution is captured by inequality indices; the links between functional and personal income distribution are explored using inequality decomposition techniques; there is an explicit formulation of the financial system and the balance sheet structure of households that allows a richer consideration of the interaction between income and wealth. Contrary to all aforementioned models, the model of this paper is dynamic in nature: it explicitly tracks the stocks and flows of the macroeconomy in a sequential manner
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