INFLATION AND INEQUALITY IN A GROWING ECONOMY WITH CASH AND CREDIT GOODS

Abstract

We develop a dynamic general equilibrium growth model, where households purchase final goods on cash or credit and have different capital and money endowments, to investigate whether inflation affects trends in income and consumption inequality. We show that, under a strong substitutability between cash and credit goods, inflation has a negative relationship with income inequality, but a U-shaped relationship with consumption inequality. The divergence between income and consumption inequality explains several recent empirical observations. This result has important policy implications, as consumption inequality better reflects the welfare distribution whereas income inequality fails to capture consumption disparities resulting from different consumption and asset distributions across households. In the growth model with heterogeneous households, there is a mixed relationship between growth and income inequality, confirming the existence of the Kuznets curve. The inflation-driven asset reallocation might also produce a Mundell–Tobin effect, enhancing growth.