Democracy, Inequality, and Inflation

Do democracies suffer higher inflation than nondemocracies? We identify two competing hypotheses regarding the impact of democracy on inflation. In the “populist†approach, inflation is the result of public demands for transfers financed by the inflation tax, suggesting that electoral competition will increase inflation. In the “state-capture†approach, inflation is a result of pressure from elites who derive private benefits from money creation, suggesting that electoral competition may constrain inflation. We present a simple model that captures both ideas and argue that the impact of democracy is conditioned by the prevailing level of income inequality. This claim is tested with data from more than 100 countries between 1960 and 1999 using different dynamic panel estimation methods to control for unobserved effects and the potential endogeneity of some independent variables. We find robust evidence that democracy is associated with lower inflation in lower-inequality countries but with higher inflation in higher-inequality countries.The authors thank Michael Bailey, Robert Cumby, Philip Keefer, Torsten Persson, Dennis Quinn, George Shambaugh, David Stasavage, and David Strömberg for comments on early drafts. The central bank turnover data used in this paper were generously provided by Jakob de Haan. Previous versions of this paper were delivered at the annual meetings of the Midwest Political Science Association and American Political Science Association. Financial support from the Edmund A. Walsh School of Foreign Service and research assistance from Jorge Ugaz and Mouneer Odeh are gratefully acknowledged.