The effects of financial crisis on income inequality

Summary Motivation Do financial crises affect everyone equally? Despite the growing concern about income inequality recently, mixed empirical findings have resulted in a long‐standing debate about the distribution of income in the aftermath of financial crises. Purpose The study examines how different types of financial crises affect the distribution of income. Methods and approach In this study we used a two‐step system Generalized method of moments (GMM) model to explore the effects of financial crisis on income inequality. Findings Any type of financial crisis results in a larger income gap between the rich and the poor. Although little attention has been given to debt and twin and triple crises, they are associated with higher income inequality than banking and currency crises. We also show that the effects of banking crises on income inequality in low‐income, lower‐middle income and upper‐middle income countries (LICs, LMICs and UMICs respectively) are more pronounced than in high‐income countries (HICs). Policy implications Long‐ and medium‐term plans for social assistance programmes in LICS, LMICs and UMICs are needed and should be flexible so that social safety nets can be rapidly adjusted to protect vulnerable groups. Maintaining a high level of fiscal balance during tranquil periods is critical to implementing welfare state expansion policies in times of crisis. Top marginal income and estate taxes should be raised to avoid very high concentrations of income in the aftermath of financial crises. The minimum wage should also be raised to protect low‐income workers.