Integration, Contagion, and Income Distribution - Regional Science Matters - page 140

Flight Episodes
Equity-led: 2007Q2-Q4
Debt-led (excl. banking flows): 1999Q2, 2005Q4; 2009Q4-2010Q2
Bank-led: 1999Q2-Q3; 2002Q4-2003Q2; 2004Q3; 2006Q1-Q2

Retrenchment Episodes
Debt-led (excl. banking flows): 1998Q1-Q2; 2008Q1-Q2; 2012Q2
Bank-led:

1996Q4-1997Q1; 1998Q3-Q4; 2002Q1-Q2; 2004Q4-2005Q2;

2008Q3-2009Q1; 2012Q3

Thus, the rise in capital flow volatility has not been uniform; debt and bank-led
flows occurring most frequently. This poses challenges for financial stability. Yet,
as long as ultra-easy monetary policy continues in advanced economies, capital
flows are unstoppable and the threat to financial vulnerability remains. How this
affects welfare, particularly when income inequality is measured, is examined next.

9.4 Financial Development and Income Inequality: A Model

Framework

9.4.1 Model Framework

The links between financial development and income inequality is depicted in
Fig. 9.7 ; the left part represents the dynamics in goods and factor markets (real
sector) including exports and imports, with the right side the workings of financial
markets. How the two interconnect determines the nature of the link between
financial sector development and income inequality.
The real sector establishes the income generation from output production (X),
with a portion covering the domestic market (D) and exports (E). Together with
imports (M), those sold in the domestic market generate the total supply of goods
and services (Q). In both allocations, the substitution is imperfect (not cost-less). 18
The process that generates output production (X) follows a standard input-output
framework, where value added (VA) and intermediate inputs (INTM) jointly
determines the level of output production (X). Expanding production networks
and supply chains—where the location of production is different from the country
where the intermediate inputs (INTM) are produced—suggests the need to distin-
guish between imported intermediate inputs (FINTM) and domestically produced
intermediate inputs (DINTM). This distinction is important particularly for trade

18 In a standard computable general equilibrium (CGE) model, for example, the allocation between
the domestic market (D) and imports (M) follows Armington's constant elasticity of substitution
(CES), while the allocation between domestic market (D) and exports (E) follows a constant
elasticity of transformation (CET).