Discussion Papers, Ibero America Institute for Economic Research 222
In this paper we contrast the impact of the income gap between formal and informal sector on Mexico's income inequality to alternative explanations. Unlike previous studies we take a time series approach to analyze the determinants of income inequality for the period 1987-1999. We find that an increase in the wage gap between the formal and the informal sector and in the wage gap between the higher educated and the lower educated people leads to an increase in inequality. Inequality seems to be counter-cyclical, that is, an increase in output leads to a reduction in inequality. An unexpected result is that inequality declines when output is below its long term trend. We obtained mixed results about the role played by prices and inflation on inequality.