The Inflation-Distribution Nexus: A Theoretical and Empirical Approach

Abstract

There are two unconnected strands of the inflation-distribution literature, one that studies the impact of inflation on income distribution and the other the impact of distribution on inflation. This paper is an attempt to fill a gap in this literature, by taking into account the simultaneous determination between inflation and income distribution. We set forth a Post-Keynesian model in which inflation and income distribution are jointly determined in a dynamical system of difference equations. The theoretical framework advanced in the paper allows us to show that conflicting claims on income, expectation formation and the realisation of increasing returns to scale ascribed to demand-pull and distributive factors also play a key role in the determination of the inflation and income distribution dynamics. Then, we conducted an empirical investigation of the relationship between inflation and distribution. Both empirical exercises were done using GMM estimator. This econometric technique is robust to reverse causality as it uses lagged observations in difference and level of endogenous variables as instruments and hence is the preferred method of estimation. Our findings corroborate our theoretical model by showing that, in average, increases in the wage share tend to exert a downward pressure in future inflation. Our estimates also show that the wage share is highly dependent of its past values, thus suggesting that income distribution may be only sensitive to autonomous (political) factors.