This paper investigates the relationship between income inequality, financial development and economic growth from both a theoretical and an empirical perspective. This paper introduces a simple model in which the effect of inequality on growth depends on the degree of development of the domestic financial market. The model predicts that greater inequality reduces growth in economies with low levels of financial development but that this effect is attenuated in economies with more developed systems. Using a panel dataset that covers a large number of countries over the past four decades, this paper shows empirical evidence that is consistent with the main prediction of the model. The model also predicts that individuals in economies with developed financial markets have a higher tolerance to inequality; we also provide evidence for this through value surveys. Overall, this paper`s major findings highlight that some of the pernicious effects of inequality can be attenuated by improving access to credit.
JEL Classification: D3; E6; P1; O4; I2
Keywords: Financial development; growth; inequality; income distribution; private credit.
