Households’ Income Inequality Under Inflation

In the process of China’s economic development, it is an indisputable fact that price levels continue to rise in the long run. Rising price level has not only affected the stability of economic growth, but also has made the growing income inequality from bad to worse. In China, micro basic conditions, between urban and rural areas, among the urban and rural areas themselves, between different income levels in urban areas or rural areas, and among the sub-items of household income appear to be non-homogeneous. The impact of the redistribution effect of inflation on the household income inequality tends to be heterogeneous, which further exacerbates the household income inequality, resulting in economic and social imbalances.Redistribution effect of inflation comes in two ways. One is the micro-effect. The structure of household income changes due to inflation, which further changes household consumption pattern.in turn, changing in household consumption pattern will affect the structure of household income. In this way, there tends be a cycle effect between the structure of personal income and consumption, which will have a positive impact on household income inequality in the long-run. The other is the ‘Cantillon effect’. Inflation may result in the flow of economic resources for profit or benefits, which then may enlarge the income gap between the traditional industries and emerging industries.The redistribution effect of inflation is taken as the theme of study in this dissertation. Based on the theories of macroeconomics, microeconomics and financial economics, and with the application of theoretical modeling, kernel density estimation, time series analysis of filtering and autoregressive distributed lag model, econometric analysis of Dynamic Panels and Panel TOBIT models, and comparative analysis, the theory and effect of the impact of inflation on household income inequality are explored and discussed in this dissertation. What is the mechanism of the impact of inflation on household income inequality? Is there a positive relationship between inflation and household income inequality? How does inflation affect the income inequality of urban and rural households as a whole, and how does it affect the income inequality of urban area and rural area respectively? How does it affect the income share among households with varied level of income? How does inflation affect the concentration ratio of households’ sub-item income. How the share of sub-item income of each household at different income level is affected by inflation. While dealing with the inflation shocks, how the decision making is affected by the feature of the head of household and the feature of household occupation, household human capital, household material capital and social background? The study of all these problems will help the authorities in making more targeted policies to stabilize price and control the income inequality.There are seven chapters in this dissertation. In chapter one, the background and significance of the paper are firstly introduced; then the literatures concerning the effects of inflation on the domestic and international income inequality are combed; after that the basic ideas and framework of this thesis are given in this chapter; finally the data sources and innovations of this dissertation are specified. In chapter two, an equilibrium model of heterogeneous consumers is established, and the mechanism of how inflation affects households’ total income inequality and sub-item income inequality are dwelled on. In chapter three, based on the measurement of China’s inflation and income inequality, and the analysis of their features, the dynamic correlation between inflation and income inequality is examined with the use of autoregressive distributed lag model. In chapter four, by using the data of China’s provincial level of Gini coefficient, the inflation rate, financial development, education, urbanization and so on, a dynamic panel model is established to test the total impact of inflation on the households’ income inequality. In chapter five, a dynamic panel model is established to test the structural effect of inflation on the concentration rate of urban households’ sub-item income in China. In chapter six, using CHNS data, a panel TOBIT model, including variables like households’ human capital, material capital, the feature of household head and households’ occupation, is established to test the households’ feature effect of inflation’s impact on income inequality. In chapter seven, the main conclusions of the dissertation is summarized; and combined with relevant conclusions of empirical research, targeted countermeasures and suggestions on how to stabilize prices and control income inequality are proposed; finally, the prospect of follow-up study is put forward prospect.The main contents and conclusions of this dissertation are as follows:1.Based on the assumption of the indefinite life cycle, an equilibrium model of heterogeneous households is established to elaborate the dynamic mechanism of impact of the inflation on households’ income inequality, which are both the starting point of the dissertation and the foundation for further studying. The credit market is assumed to be imperfect, which means households at different income level will face different investment opportunities. Families at middle and low income level tend to face relatively limited investment opportunities due to factors such as human capital and material capital. Meanwhile, these families usually cannot get enough credit support in the credit market due to the "threshold effect", which makes it common for them to pay in cash while facing the investment opportunities. Whereas for families at high-income level, investment opportunities are relatively more than those at lower income level. Meanwhile, it is relatively easier for them to get support from financial institutions, which leads to the higher ratio of using credit instead of using cash while facing investment opportunity. Under the above assumptions, families at middle and low income level have to face to higher contraint of prepaid cash in the process of investment. With budget constraints(including the total budget constraints and prepaid cash constraint), Families at different income levels will choose their own path of consumption, labor supply mode, the capital stock and the amount of money to hold to maximize the present value of their lifelong utility.Long-run inflation tends to reduce the rate of capital accumulation. but in the process of capital formation, at least some investment opportunities need to be paid in cash, which will have a relativelly larger impact on the families at middle and low income level. That is to say, higher inflation leads to higher income inequality on the condition of equilibrium, which means a positive effect between inflation and household income inequality. On this basis, steady-state value of total income is obtained. After that, the structural effect of the impact of inflation on the saving rate, investment income, labor income, net interest income, and transfer income of the families at different income level are discussed in-depth.2. After analyzing the features of China’s inflation and households’ income inequality respectively, the dynamic correlation between household income inequality and inflation, predictable inflation and unpredictable inflation is analyzed respectively. Households’ income inequality shows the following characteristics: the income inequality has a tendency of widening, and rural income inequality is higher than urban income inequality. For urban households, wage income inequality contributes the most to the urban income inequality, which means wage income inequality is the main source of urban income inequality; transfer income contributes the second to the urban income inequality and the concentration ratio is less than urban GINI coefficient since 2004; net operating income contributes relatively less to the urban income inequality. However, it shows an upward tendency with fluctuation. The concentration ratio of net operating income is more than urban Gini coefficient since 2007. Property income contributes the minimum to the urban income inequality, and the concentration ratio is the highest among sub-item income. For rural households, net operating income and wage income contribute the most to the rural households’ income inequality. The concentration ratio of net operating income tends to move upward slowly, but it is still less than the rural households’ Gini coefficient, while the concentration ratio of wage income shows a downward tendency; The extent and direction of the impact of inflation on the redistribution of income tends to be different due to the differences in the performance, factors, extend and duration of inflation. In this paper, Granger causality test and autoregressive distributed lag model are used to analyze the dynamic correlation between inflation and income inequality. The results of the study show that, whether it is in the long-run or short-run, there is a positive effect between households’ income inequality and inflation, predictable inflation and unpredictable inflation. Moreover, income inequality has the "Matthew Effect"; there is a lagged effect of inflation on income inequality. In the long run, inflation exacerbates the income inequality. To rural households, this effect is even more than that of urban households. The impact of predictable and unpredictable inflation on urban households can be larger than that on rural households.3. A dynamic panel model is established to analyze the impact of inflation on the income inequality in China’s urban area and rural area respectively, and on the income inequality between the urban area and rural area. After that, the impact of inflation on the income share of urban households at different income level is analyzed. The results show that the inflation has a spot positive effect on income inequality, regardless of urban area, rural area or between urban and rural area. The spot positive effect on rural households’ income inequality is the highest while the effect on the urban households’ income inequality is the lowest. Except for the urban households with the highest level of income, inflation will reduce the income share of other groups at other income levels. Inflation has the highest negative spot effect on middle and upper-middle income level groups. It has positive lagged effect on high and the highest income level groups, which means the high income level group has an ability to adjust themselves to the inflation. In an inflationary environment, the financial development to ease the urban, rural and urban-rural income inequality, but the effect on the residents of the smallest towns; for middle-income groups, the middle-income group, the high-income group and the highest income groups of urban residents have positive immediate interaction, and this immediate interaction greatest impact on middle-income group and middle-income groups of urban residents. The interaction effect between financial development and the first-lagged inflation intensified urban income inequality. However, it eases the income inequality between the urban and rural households. This effect has a highest positive effect on urban households group with high income. It has the second highest effect on the upper-middle income group of urban households while not significant statistically. The effect on the highest income group of urban households ranks the third. Spot effect of interaction between inflation and education has the highest positive effect on upper-middle income level group of urban households. The effect on the middle income level ranks the second. The interaction effect between the education and the first-lagged inflation eases the urban households’ income inequality, but it intensifies the rural households’ income inequality, which means this effect only has an impact on urban households within the group of the highest income. The urban Gini coefficient, the rural Gini coefficient and the Gini coefficient between urban and rural area have a significant first-order memory which is strongest in urban area. "Matthew." Effect is observed in the groups of the high income and the highest income.4. The structural effect of inflation on the concentration ratio of urban households’ wage income, net operating income, transfer income and property income is analyzed. The results show that:(1) the rate of inflation has a first-lagged positive effect on the concentration ratio of wage income; the interaction effect between financial development and lagged inflation exacerbated wage income inequality; while the interaction effect of education and lagged inflation will ease the wage income inequality of urban households.(2) inflation has a negative spot effect on the concentration ratio of net operating income; the interaction effect between financial development and inflation will ease the net operating income inequality of urban households; the interaction effect between education and inflation exacerbates the net operating income inequality of urban households; unlike the concentration ratio of wage income, the concentration ratio of net operating income can be accumulated.(3) inflation has a positive spot effect on property income inequality, which will exacerbate property income inequality of urban households; the interaction effect between the financial markets and the first-lag inflation reduces the property income inequality of urban households; while under inflation, education can ease the property income inequality of urban households; it is inevitable that there is a "Matthew" Effect in property income inequality.(4) Inflation eases the transfer income inequality of urban households; under inflation, financial development eases the transfer income inequality of urban households, while education will exacerbate transfer income inequality of urban households.5. Inflation has a structural effect on sub-item income of urban households at different income level. The study results show that:(1) inflation has a negative spot effect on the high income group and lower-middle income group of urban households, and the effect on the high income group is greater than that on the lower-middle income group; inflation has a negative lagged effect on middle income group and lowest income group while it has a positive lagged effect on the highest income group, which means the middle and low income households groups have no adaptability to inflation.(2) Under inflation, the share of net operating income in the low-income group, middle-income group and upper-income group is greatly improved while that share in the high-income group and the highest income group is reduced, which eases the net operating inequality among high income house urban households.(3) Inflation reduces the share of property income in the low-income group, but it increases the share of property income in high-income group; the lag effect of inflation increases the share of property income in the lowest income group, in the lower-middle income group, in the middle-income group, in the high-income group and in the highest income group, but the urban households at high-income level are affected even more, which means the high income group of urban households benefits the most in property income from inflation.(4)Except for the lowest-income group, inflation significantly reduces the share of transfer income in all other groups. And as the income level increases, the negative effect on these groups increases accordingly, which means inflation will help to realize the “positive distribution” effect of transfer income.6. A family’s decision on how to deal with the impact of inflation can affect the households’ income inequality. Therefore, the China Health and Nutrition Survey(CHNS) data are used to analyze the family features of the redistribution effect of inflation by constructing variables with family features and family-head features. The results show that: after controlling other factors, education plays an important role in the relative income a family gets due to its cognitive advantages in predicting, identifying and adapting to inflation. The per capita market value of a family’s real estate property significantly improves its economic status, but it also weakens its ability in withstanding the shock of inflation, lowering its economic status accordingly under inflation. The age of the head of a family will enhance the ability of families to withstand the shocks of inflation, but the benefits of the variable of age increase at a declining rate, which means there is a difference between the most older workers and relatively younger workers; for urban households, the male head has a significantly higher ability than that of the female head; The variable of occupational features does not have much explanatory power. For rural samples, with the increase in income level, the ability in withstanding the shock of inflation also improves, though it is not significant to the high income group; the lower-middle income urban households suffer most from the shock of Inflation.7. Given the heterogeneity of the redistribution effect of inflation, policy suggestions aimed at two aspects, price stabilizing and income inequality controlling, are put forward. These suggestions include taking measures to stabilize the total price level and to enhance information disclosure of inflation and the change of inflation expectation; meanwhile, measures must be taken to perfect households’ income structure and to develop education to improve households’ ability in identifying inflation and withstanding the shock of inflation. Financial market system must be reformed and perfected to improve households’ ability to fight against inflation shocks.The innovation of this paper is mainly reflected in the following three aspects:1. Innovation in researching perspective. In the process of economic development, issues about inflation and the widening of income distribution have been paid a lot of attention both in theory or practice. However, studies about the relationship between the inflation and the gap of income distribution are rare. In this dissertation, the evolution of income inequality is analyzed in-depth from the perspective of inflation.2. Innovation in the contents of research. Domestic literatures paid little attention to the basis of research in economic theory while conducting research on the impact of inflation on income inequality. In this dissertation, based on the theory of indefinite life, an economic equilibrium model is established to analyze the mechanism of the impact of inflation on the households’ total income inequality and households’ sub-item income inequality. Empirical research is done from three aspects: total effect, structural effect and family feature effect. The effect of inflation on the households at different income levels is also analyzed.3. Innovation by using CHNS data(large survey data of family in microscopic aspects). It is the first time that the CHNS data are used to test the family features of households’ income inequality under inflation. Use of the CHNS survey data is not only to form an effective complement to the macroeconomic data based research in the impact of inflation on the redistribution, but also, compared with macroeconomic data, has an incomparable advantage in revealing the effect of price level fluctuations on the households while they face the inflation and withstand the shock of inflation.