Geoscience Reference
In-Depth Information
flows and income distribution is specified in detail by dissecting the flows as they
appear on agents' balance sheets based on the type of income generated.
Scrutinizing the role and detailed transmission within the financial sector allows
us to analyze the dynamics of income earned from returns on financial assets held
mostly by urban-based rich households. 26
Given the shock from increased bank-led flows, two scenarios are constructed:
one where recipient banks increase risk by investing in financial assets, particularly
securities and equity markets; and the other where recipient banks spend the
additional funds more prudently, by using them to strengthen credit and safe assets.
In the first scenario (Figs. 9.8a, b , c), real GDP is only slightly higher than the
baseline. So are investment and consumption. Inflation and unemployment rates are
lower. However, the trade sector suffers: exports decrease and imports increase due
to currency appreciation. Looking more closely, appreciation derives from higher
interest rates, their level influenced by returns on financial assets. Because the
issuance of financial assets increases under this scenario, prices will fall and yields
rise, with interest rates also increasing. In the search for higher returns and yields,
banks actively invest in these new assets instead of issuing more credit. This
explains why the economy grows only slightly.
The effect on income distribution is far more obvious: it gets worse. Whether
measured by disparity between rich and poor, or in terms of the rural/urban gap,
inequality grows (Fig. 9.9a, b ). Although the poverty line drops 1.2 % below the
baseline, incomes for all household categories fall, despite growing GDP. Two
factors are behind this: (1) wages fall due to lower prices, and (2) economic growth
is mostly driven by expanding financial sector-related activity. These tend to benefit
only urban-rich households whose depend far less on wages (factor income) than
the rural-based poor. With more access to financial markets, the urban-rich accrue
extra income from returns on the financial assets they hold. This is why increased
bank-led flows under the risky behavior scenario worsen income inequality. And as
expected, the largest deterioration is in financial income.
How does this compared with a scenario of prudent bank behavior? While real
GDP in both cases is higher than the baseline, the increase is larger when banks act
more prudently. There is higher growth in investment and consumption due to
lower interest rates, and higher exports due to nominal and real exchange rate
depreciation (see Fig. 9.8a, b ). Unemployment rate is also much lower, though the
price index is higher (see Fig. 9.8c ). Thus, the macroeconomic impact is better
when banks behave prudently.
Unlike the previous case, income in all household categories increases. More
importantly, all factor incomes are higher. As increased liquidity from bank-led
flows is not spent on financial assets, the urban rich do not receive extra income
26 The model version used in the analysis here follows Min ( 2014 ). Due to space constraint, the
detailed explanations of the model and simulation results are not shown here (they are available
upon request).
Search WWH ::




Custom Search