Inflation, financial development, and income/wealth inequality in the European Union

In the post-pandemic period, the debates about high inflation and widening income inequality have intensified. This study examines the 27 countries in the European Union over the period 1990–2023 using panel data models (mean group estimators and system generalized method of moments estimators). Inflation increased income inequality, but decreased wealth inequality. Domestic credit to the private sector and government expenditure exacerbated income and wealth inequality, whereas trade reduced income inequality, proxied by the Gini index. The interplay between credit and inflation reduced income and wealth equality, measured by top 10 percent share, the bottom 50 percent share, and the top 1 percent share. The interaction between inflation and other financial development indicators related to institutions and markets reduced inequality. Control of corruption reduced wealth inequality. We also explore the potential impact of domestic credit to the private sector on income and wealth inequality by constructing a causal model that examines the role of self-employment as a mediating factor. Inequality decreased self-employment, whereas domestic credit to the private sector encouraged it. These empirical findings offer insights into how to reshape policies to manage both inflation and high income/wealth inequality.