Inflation and Income Inequality in Developed and Developing Countries

The main objective of this article is to investigate both linear and nonlinear effects of inflation on income inequality and to test the Kuznets hypothesis using panel data of 24 developed countries (DCs) and 66 developing countries (LDCs) observed over the period of 1990 to 2014. Additionally, we explore the short- and long-run Granger causality relationship between inflation and income inequality using the Toda-Yamamoto (1995) procedure and a vector error correction model (VECM) approach. The existence of a nonlinear relationship between inflation and income inequality is confirmed implying as inflation rises income inequality decreases. Income inequality then reaches a minimum and then starts rising again. The findings of this article show the existence of Kuznets' 'U-shaped' hypothesis between income inequality and real GDP per capita in DCs group, and the existence of Kuznets' inverted 'U-shaped' hypothesis for LDCs group. The results indicate that there is no bidirectional Granger causality between inflation and income inequality in the short-run, but, there is bidirectional Granger causality in the long-run for both the DCs and LDCs group. The results help us to assess the effectiveness of monetary policy in reducing income inequality in both the DCs and LDCs group. As a policy implication, monetary policy is often aimed at controlling the annual rate of inflation in the long-run with a short-run focus on reducing output gaps and creating employment. However, managing inflation may have implications for income inequality