Inequality and the Inflation Tax

Abstract

Numerous studies document a positive correlation between inflation and income inequality. I show that this correlation has reversed, most notably in the European economies. More generally, the sign of the correlation depends on the time period and sample of countries. In the literature on the political economy of inflation, monetary financing and income taxes are substitutes. Correspondingly, as the correlation between inequality and inflation has become more negative, the correlation between inequality and income tax revenue has become more positive. Cross-country and panel regression analysis suggests that in democracies, independent central banks can resist political pressures for inflation that rise with inequality.

Keywords: inflation, inequality, political economy, central bank independence, democratization, seignorage

JEL Classification: D31, E31, E50, P16