Inflation and Income Inequality in Developed Economies

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This paper explores the empirical link between income inequality and inflation in ten OECD  countries  over  the  period  1971  to  2010. In  addition  to  inflation,  we  include  six control  variables  in  our analysis:  economic  development  level,  business  cycles, unemployment,   unionization,   openness   to   international   trade   and   skill-biased technological change. We estimate the empirical link between all seven variables and income  inequality  with  a  balanced  panel.  We  find  a  U-shaped  link  between  long-run inflation and income inequality. Low inflation rates are associated with higher income inequality.  As  inflation  goes  up,  inequality  decreases,  reaches  a  minimum  with  an inflation rate of about 13%, and then starts rising again. The precise mechanisms that lead  more  inflation  to  correlate  with  a  decrease  in  income  inequality  until  a  certain threshold are unclear yet, and warrant further research.