Effect of Inflation on Income Distribution

Deergha Raj Adhikari, Denis Boudreaux and S.P. Uma Rao
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Deergha Raj Adhikari: Department of Economics and Finance, University of Louisiana at Lafayette, LA - USA
Denis Boudreaux: Department of Economics and Finance, University of Louisiana at Lafayette, LA - USA
S.P. Uma Rao: Department of Economics and Finance, University of Louisiana at Lafayette, LA - USA

Economia Internazionale / International Economics, 2025, vol. 78, issue 3, 375-390

Abstract: In this study, we attempt to examine if inflation has any impact on income distribution (the GINI coefficient). To find that out, we applied VECM on the variables GINI coefficient (a measure of income inequality or income distribution) and INF (inflation rate) on US data from 1990 to 2020. We find that while inflation has no impact on income distribution in the short run, it has a negative impact in the long run. The possible explanation for inflation to have negative impact on Gini coefficient in the long run is that although the rich people derive their income from profit, rent, and interest which tend to increase during inflation, but if interest paid to own rental properties rises by such a greater proportion than the proportionate rise in rent that the difference between the two rises is so large to offset the rise in interest income following an inflation episode, then the income ratio must fall causing income inequality between the rich and the poor to decline thereby lowering the value of Gini coefficient, which is exactly what might have happened in U.S. case over the study period. On the other hand, the possible explanation for the finding that inflation had negative but insignificant impact on Gini coefficient in the short run is that, when inflation occurs and passes the threshold set by the central bank (e.g. the Federal Reserve in the U.S.), it raises the target federal funds rate, which then causes all other interest rates to rise. However, the Fed responds, with a lag, to any change in inflation rate, output and employment as collecting and analyzing the relevant data and formulating an appropriate policy and implementing it takes time, the Fed’s contractionary monetary policy to combat inflation comes with a lag too. Also, even when the Fed raises the federal funds rate to combat inflation, the transmission mechanism through which the federal funds rate influences other interest rates takes some time to play itself out. Further, if economic agents view this hike in federal funds rate as a temporary phenomenon, they may not respond the way expected and the rent and other interest rates may remain unaffected in the short run. As such, the effect on earnings of high-income people coming from raised interest rate and rent following a contractionary monetary policy of the Fed also comes with a lag. Therefore, any effect of inflation on high-income people’s earning and thereby on Gini coefficient migh have been absent in the short run.

Effetti dell’inflazione sulla distribuzione del reddito

In questo articolo cerchiamo di stabilire se l’inflazione ha un impatto sulla distribuzione del reddito (coefficiente di GINI). A questo scopo si applica il modello VECM sul coefficiente di GINI (una misura di disuguaglianza nella distribuzione del reddito) e il tasso di inflazione INF sui dati relativi agli USA nel periodo 1990-2020. È stato riscontrato che l’inflazione determina effetti sulla distribuzione del reddito solo nel lungo periodo, non nel breve periodo. Una possibile spiegazione di ciò può essere che la popolazione più ricca ricava il suo reddito dai profitti, dalle rendite e dagli interessi, forme di reddito che durante l’inflazione tendono ad aumentare. Tuttavia, se gli interessi pagati per acquisire una proprietà aumentano in proporzione maggiore dell’aumento della rendita, così che la differenza è talmente elevata da compensare l’aumento degli interessi dovuto all’inflazione, allora la quota di reddito dei ricchi scende causando nel breve periodo una diminuzione della disuguaglianza del coefficiente di GINI. Si può supporre che ciò sia successo negli USA nel periodo citato. Un’altra spiegazione possibile dell’effetto negativo ma non significativo dell’inflazione sul coefficiente di GINI nel breve periodo potrebbe essere che quando un fenomeno inflazionistico si verifica e supera il target fissato, la Federal Reserve aumenta il tasso di interesse sui Federal Funds, determinando di conseguenza un aumento

Keywords: GINI Coefficient; Income Distribution; Inflation; VECM; VAR (search for similar items in EconPapers)
JEL-codes: E31 E52 E64 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:ris:ecoint:022215

DOI: 10.65644/EIIE.078.03.0375

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