Does inequality cause inflation?: The political economy of inflation, taxation and government debt

Abstract

A democratic society in which the distribution of wealth is unequal elects political parties that are likely to represent the interests of poor people. It is in the interests of the clientele of the resulting governments to attempt to levy inflation taxes in order to erode the real value of debt service and redistribute from the rich to the poor. Consequently, inequality and high levels of nominal government debt sow the seeds for inflation. Some cross-country evidence for this proposition is provided.

Democracy, populism and hyperinflation: some evidence from Latin America

“…In addition, in columns 5 and 6 we report the estimates of the dummy variable (DU M M Y ) for the …rst eight years after re-democratisation, and the estimates are positive and statistically signi…cant, which indicate that in ‡ation was indeed higher for the …rst two terms right after democratisation. Essentially, these static and dynamic estimates are in accordance with the literature on populism and in ‡ation (e.g., Sachs (1989), Dornbusch and Edwards (1990)), which articulates the idea that in young democracies that are faced with demand for redistribution, populist policies are likely to be pursued in an attempt to please the median voter (Beetsma and Van der Ploeg (1996), and Desai et al (2003)). …”

“…Moreover, Beetsma and Van der Ploeg (1996) argue-theoretically and empirically (they run cross-country regressions of in ‡ation against inequality for the period -that in unequal societies, and South America …ts the bill again, the government tries to please the median voter, or the poor in this case, via redistribution; and, although not dealing speci…cally with South America, Desai, et al (2003), use a large panel data set and OLS and Fixed E¤ects estimators, to suggest that it all depends on how unequal a country is (democratisation taking place in unequal countries lead to populist policies and hence high in ‡ation, a factor that can, again, be related to the South American case) 3 .…”

Income inequality and inflation: the cross‐country evidence

“…Al-Marhubi (1997) presents some preliminary evidence that relates income inequality and inflation for a large set of countries. Beetsma and van der Ploeg (1996) find inequality significant in explaining inflation for democratic but not for nondemocratic countries. region's inflation explosions.…”

Do policymakers' distributional desires lead to an inflationary bias?

“…where Si.t is the income share of the/th quintil¢ and t is time) Second, we have estimated Equation 4 with two-stage least squares instead of with ordinary least squares to reduce the problem of simultaneity bias, which may result from inflation policies aimed at affecting the income distribution (compare Beetsma and van der Ploeg, 1992). The estimation results are presented in Table 1.…”