Income distribution and economic cycles in an open-economy supermultiplier model

Abstract

We build a structuralist supermultiplier model for a small open economy with two sources of autonomous demand, government expenditures and exports. We find that, in the long run, there is a limit for government spending: its growth rate cannot exceed that of exports without generating an external crisis. However, there is a strong role for public policy, since there is nothing that automatically leads the economy to its maximum growth rate compatible with the external constraint to growth. In the short run, we find an additional restriction, related to income distribution. Since higher wages increase consumption and economic activity, they also require more imports, potentially leading to unsustainable debt growth. Therefore, there is a maximum real wage compatible with external equilibrium. If real wages targeted by unions exceed those compatible with balance-of-payments equilibrium, the economy can display economic cycles between capacity utilisation, income distribution and indebtedness, marked by permanent inflation.