Does struggling inflation affect income inequality or is inequality causing high inflation?

Nowadays Kazakhstan belongs to countries with developing economies, which, according to official indicators, differ from countries with low levels of income inequality (see Table 1), which is especially noticeable when compared with Russia.

Table 1. Income inequality indicators in selected countries

                                                                                                  Source: compiled by the author based on country statistics

However, due to the specifics of statistical calculation, the Gini coefficient and assets ratio do not reflect the actual picture of the level of income inequality in the country. For example, in the Inflation Review of the National Bank of the Republic of Kazakhstan (March, 2019), there was given a summary that deposits worth over 500 million tenge belong to depositors, whose share was only 0.015% of the total number of depositors. At the same time, these deposits accounted for 20% of the total volume of deposits in Kazakhstan. Deposits from 50 to 500 million tenge, which constitute 18% of total deposits, belonged to only 0.02% of depositors. Overall, less than 1% of depositors owned more than 38% of the country's deposits. Unfortunately, these statistics have no longer been updated. However, according to KDFG statistics, it is also possible to detect the presence of income inequality: at the beginning of 2020, the mass segment of deposits (with balances up to 20 million tenge), occupying 76% of the total volume of deposits, belonged to 94% of depositors. In other words, only 6% of depositors owned large and medium deposits. Despite the fact that in 2022 the share of the mass deposit segment began to decline (to 50%) in the total volume of deposits, this segment remains dominant in terms of the share of depositors.

Thus, the problem of income inequality remains relevant in Kazakhstan. Considering that the degree of income inequality in Kazakhstan is indirectly revealed precisely in deposit statistics, it is interesting to look at this in relation to the tight monetary policy pursued in the country over the past few years. The question arises: does strict monetary policy increase the degree of income inequality or, conversely, income inequality itself generates a high level of prices in the economy, forcing the central bank to tighten monetary conditions?

In conditions of a significant deviation of inflation rates from the target corridor, the National Bank is carrying out activities to tighten monetary policy, which, first of all, is characterized by increasing the base interest rate and maintaining it at a high level. By reducing consumption, interest in borrowed funds and investments, as well as increasing savings, the central bank tries to contain the rate of inflation and prevent a critical increase in prices in the economy.

However, monetary policy has a wide range of transmission mechanisms that can affect both target and non-target economic indicators. One of the non-target indicators may be inequality in society. The work of Nelyubina A. is indicative here.

Using the example of Russia, the economist in her work showed six transmission channels that can have an impact on inequality as a result of the implementation of monetary policy. It is noted that in these channels there is heterogeneity of impact due to the heterogeneous characteristics of the population (sources of income, availability of savings, involvement in the financial market, work experience, age, etc.) Both tightening and easing monetary policy lead to income inequality. At the same time, there are cases where monetary policy has had no effect on inequality at all.

However, analyzing the relationship between income inequality in the regions of Russia and monetary policy as a whole, the author came to the conclusion that in the medium term, with a tightening of monetary policy (increasing the key rate by 1 percentage point), income inequality in Russia is reduced by 0.7 -1.2% after a year, and vice versa. But this effect may weaken due to the effect of the income structure channel and the Fisher channel. Due to these channels, when the key rate increases, real wages decrease and interest rates rise, which, on the contrary, leads to an increase in the income gap.

At the same time, the author notes that the model specified in the article is built on a number of assumptions, so the possibility of a situation where inequality itself affects monetary policy cannot be ruled out.

The main goal of the central bank is to ensure price stability within the state. The central bank tightens or softens monetary policy depending on the level of inflation in the country. Despite the fact that the mechanism for tightening or easing monetary policy among central banks committed to inflation targeting is the same, the results are different. In some countries, monetary policy has a faster impact on inflation and requires smaller interest rate increases. So, the question is: what determines the effectiveness of monetary policy in countries?

The most interesting and relevant answer to this question for our economy is given by Philip Kartaev and Marina Samsonova in their work, where they note the least obvious factor in the effectiveness of monetary policy. The effectiveness of monetary policy depends on the level of income of the population and their involvement in financial markets. The study is interesting because it was conducted for the Russian economy, which is similar in structure to ours and whose monetary policy has long influenced the Kazakh economy.

According to the authors, firstly, depending on the distribution of income, the same monetary policy measures have a different effect on aggregate demand, and therefore on changes in the general price level (income structure channel). Secondly, the richer population has greater involvement in financial markets, while economic agents with low incomes have limited or no access to them. Thus, in a country with high income inequality, only a small part of the population benefits from rising interest rates, and the rest only suffer losses (financial segmentation channel and Fisher channel). At the same time, using econometric analysis tools, the authors show an inverse relationship between income inequality in Russian regions and inflation: higher inequality contains inflation, and its reduction leads to accelerated price growth.

This phenomenon is explained as follows: a lower degree of income inequality correlates with the share of the middle class. The lower the inequality, the larger the share of the middle class in society. The middle class does not have significant capital and does not have a large amount of loans in its portfolio - as a result, interest rate actions have little impact on middle class consumption. Interest rate changes have the greatest impact on consumption incentives among the rich class and socially vulnerable segments of the population. This is confirmed by research on the US recession of 1979–1983, which was caused, among other things, by a contraction of the money supply: the losses of low-income households were much greater than those of high-income households. The same conclusion is supported by research from Norway, which shows that the impact of loose monetary policy on household income groups can be depicted as a U. It means that it has a stronger impact on the consumption of the poorest and richest than on the consumption of households in the middle income groups distributions.

Thus, most studies show a relationship that is not very pleasant for policymakers: greater income inequality increases the impact of monetary policy on inflation.

In the context of various restrictions that the Kazakh economy has also faced, the government needs to see as clearly as possible all the channels that affect the economy when implementing a particular policy. In this case, the conclusion obtained by the researchers using the example of the economies of Russia and Norway has an important practical consequence: since the relationship between inflation and income inequality is inverse, giving the central bank an additional mandate to reduce income inequality in society (improving well-being) will become incompatible with the goal of reducing inflation. In addition, these findings are particularly useful for fiscal authorities: when combating inequality in society, the implementation of a soft monetary policy (low interest rate policy) cannot act as an instrument, since it, on the contrary, can increase the income gap.