The Role of Macroeconomic Policies on Income Inequality in Developing Countries

Abstract

: Income inequality (INQ) is a major issue to overcome in order to meet SDG 10 (reduced inequalities), especially in developing countries where fiscal and monetary policy can have opposite distributional impact. Past research focused on the effects of fiscal or monetary policy on inequality, but little research has considered the joint effects of the two policies. The focus of this study is to examine the combined impact of government expenditure, real interest rate, exchange rate, per capita income, age dependency ratio and inflation on income inequality over 55 developing countries for the period 2000–2021. The empirical results, based on a two-step System Generalized Method of Moments (GMM) and panel quantile regression, show that income inequality is negatively related to government expenditure, exchange rate appreciation, per capita income and age dependency ratio. The results show that the real interest rates and inflation have positive coefficients but these effects are not statistically significant in the baseline model. The results also reveal heterogeneous policy effects as the impact of these macroeconomic variables depends on different levels of inequality, as suggested by quantile regression. The results offer a more comprehensive picture of the effect of macroeconomic policies on income distribution. Policy implications indicate that there is a need to increase targeted public expenditure, exchange rate management and demographic factors to help reduce the level of inequality in developing countries.