Financial Development, Economics Growth, Income Inequality Nexus: A Case Study of Pakistan

The purpose of this study is to examine the interrelationship between financial development, economic growth and income inequality in case of Pakistan. The study has been divided into three linkages; one linkage is between financial development, financial instability and economic growth; second is between financial development, financial instability and income distribution or income inequality, and the last one is between financial development, financial instability and poverty via economic growth. The ARDL bounds testing approach to cointegration has been applied. Our results indicate that the variables are cointegrated for long run. Furthermore, a positive relationship exists between financial development and economic growth. Financial instability not only retards economic growth directly but also weakens finance-growth nexus. The impact of financial development on income inequality is negative. It shows that a rise in financial development improves income distribution or declines income inequality. Financial development improves the incomes of poor segment of population. This empirical evidence confirms the existence of McKinnon Conduit Effect (MCE) in Pakistan. The present study suggests suitable policy options to policy makers in declining income inequality by using financial sector as a policy tool in Pakistan.