In this paper we analyze theoretically and empirically the impact of an increase
in income inequality on the current account balance. We develop a model with
consumption externalities and heterogeneous agents which explains how an increase
in income inequality can affect negatively or positively the current account balance.
The relationship is exacerbated by the level of financial liberalization represented
by changes in the borrowing constraints. Panel data regressions for a sample of
developed and developing economies confirm that an increase in income inequality
is mostly linked to a decrease in the current account balance. Moreover, we also
find that relatively higher levels of financial liberalization interact with the level of
income inequality so that the previous effect is amplified. These results are robust
to different specifications.