Time-varying predictability of financial stress on inequality in United Kingdom

Abstract

PURPOSE : Existing empirical evidence suggests that episodes of financial stress (crises) can act as driver of growth of inequality. Consequently, in this study, the authors explore the time-varying predictive power of an index of financial stress for growth in income (and consumption) inequality in the UK. The authors focus on the UK since income (and consumption) inequality data are available at a high frequency, i.e. on a quarterly basis for over 40 years (June, 1975 to March, 2016). DESIGN/METHODOLOGY/APPROACH : The authors use Wang and Rossi's approach to analyze the time-varying impact of financial stress on inequality. Hence, the method provides a more appropriate inference of the effect rather than a constant parameter Granger causality method. Besides, understandably, the time-varying approach helps to depict the time-variation in the strength of predictability of financial stress on inequality. FINDINGS : This study’s findings point that financial distress correspond to subsequent increases in inequality, with the index of financial stress containing important information in predicting growth in income inequality for both in and out-of-sample periods. Interestingly, the strength of the in-sample predictive power is high post the period of the global financial crisis, as was observed in the early part of the sample. The authors believe these findings highlight an important role of financial stress for inequality – an area of investigation that has in general remained untouched. ORIGINALITY/VALUE : Accurate prediction of inequality at a higher frequency should be more relevant to policymakers in designing appropriate policies to circumvent the wide-ranging negative impacts of inequality, compared to when predictions are only available at the lower annual frequency.