WP 17: The impact of austerity measures on inequality: a study of Latin America and the Caribbean
This paper analyzes the dynamic effects of fiscal consolidation episodes on disposable income, market income, hourly wage, and functional inequalities in Latin America and the Caribbean, utilizing a narrative annual data set covering 1989–2016 (David and Leigh, 2018). Using the methodology proposed by Jordà (2005), we derive impulse response functions from local projections and conduct a comprehensive Gini decomposition analysis to analyze three channels through which austerity affects inequality: the redistributive effect, wage inequality, and functional inequality. Our baseline findings indicate that eight years after a fiscal consolidation episode, the hourly wage inequality index increases by 2.26%, and the labor share in income declines by 1.9%. This suggests that both channels play a significant role in explaining the rise in inequality. Regarding the redistributive channel, we found that the redistribution measure responds positively to fiscal shocks in the short run, suggesting the crucial role of the social safety net in mitigating immediate inequality impacts. However, the redistributive effect decreases in the medium run after tax-based fiscal episodes.
Fiscal austerity, wage inequality, functional inequality, local projections, Latin American countries
D30, D60, E60, E62