Nonlinear impact of financial deepening on income inequality

This paper looks at the influence of financial deepening (private bank credit) on income inequality in developed economies. Building on amodel of financially open economies (Kunieda et al. (Macroecon Dyn 18:1091-1128, 2014)), defining its endogenous economic growth rate, and extending its implications also for top income shares, it is shown that the impact of bank credit on inequality depends on the gap between the real interest rate and the GDP growth rate (`r - g'). This finding is robustly confirmed by the empirical analysis on a few samples of OECD and EU countries, both for the Gini index and for top income shares. Both the econometric evidence and simple evidence show that the presence of this type of non-linearity (an interaction between financial deepening and r - g) is likely to be one of the reasons for the mixed results that may be found in the empirical literature on the relationship between the financial deepening and income inequality.