Nexus between Financial Deepening and Income Inequality in Pakistan: Time Series Analysis

Abstract

Despite financial growth in Pakistan, income inequality remains a serious concern. It is ambiguous and debatable whether financial deepening reduces inequality or favors the wealthier. The current investigation examined the association of financial deepening with income inequality in Pakistan from 1980 to 2022. We used an autoregressive distributed lag model to investigate the statistical relationships. Financial development exhibited a positive relationship with income inequality, but its square showed a negative association with the inequality. This evinces the quadratic relationship between these two variables. Gross domestic product and trade helped reduce income inequality. This affirms that Greenwood & Jovanovich's hypothesis of the Financial Kuznets Curve (FKC) holds for the long run in Pakistan. The short-run error correction model (ECM) and long-run ordinary least squares (OLS) results revealed that initially, income inequality increased due to financial development, but in the long run, it started decreasing when financial resources were accessible to the deprived population. The findings suggest that policy designers should focus on all the regions and keep in view the whole population while formulating the financial development policies in order to minimize the income inequality.