Financial deepening on income inequality

Abstract

There exists a vast empirical literature on Financial Sector Development (FSD) and the income inequality nexus; however, it lacks consensus. To study this, 24 studies with 87 regression estimates on financial institution depth and income inequality were collected. This paper used the most common method of economic meta-analysis, the Partial Correlation Coefficient (PCC), to answer the question: What is the magnitude and impact, if any, of financial institution depth on income inequality? In addition, a multivariate meta-regression model was used to find moderator variables that produced mixed results in the literature. The results show that the global average comovement of financial institution depth (domestic credit) on income inequality is very small but positive; suggesting that growth in domestic credit may widen income inequality. The positive correlation between domestic credit and income inequality highlights how financial institutions use household income and collateral as a signal when deciding on credit applications. Finally, the multivariate regression results suggest that the present heterogeneity within the literature stems from different methodologies and control variables included in the econometric models, and panel studies that mix countries with heterogeneous characteristics. These suggest that different components of FSD may impact income inequality differently.