Income Inequality and Redistributive Responses During Financial Crises: Do the Standard Models Apply?

This paper investigates the relationship between income inequality and redistribution during financial crises. While the economic fallout following such crises leads to increases in income inequality, the redistributive responses of governments are less clear a priori. The explanatory leverage of existing theoretical models is potentially compromised by the fact that these approaches implicitly assume times of ''normal'' economic activity. Financial crises, however, are typically accompanied by serious fiscal distress, making it harder for governments to engage in redistributive activity. The paper first briefly reviews the existing standard models and the support they have in the empirical literature. We then proceed to test the relationship between inequality and redistribution during and in the immediate aftermath of financial crises. The empirical analysis utilizes cross-section and panel data on episodes of financial crises in industrialized and developing countries between 1980 and 2008.