Income inequality, inflation and financial development

The paper examines empirically whether financial development shapes the relationship between inflation and income inequality. This is motivated by the observations that while financial development provides an insurance mechanism against inflation risk, high and volatile inflation distorts information flows and interferes with the resource allocation of the financial sector. Thus, the distributional consequence of inflation may hinge on how inflation and financial development interact with each other, i.e., condition on financial development. In a sample consisting of both developed and developing countries, it finds that income inequality is positively associated with inflation but negatively correlated with the interaction between inflation and financial development. Inflation raises income inequality and financial development moderates this adverse effect. The evidence suggests that promoting financial development would attenuate the unfavorable effects of inflation on income distribution.