Is Inflation Regressive or Progressive? Long Run & Short Run Evidence from Pakistan

The present paper investigates an answer to a key question “is inflation regressive or progressive?†by utilizing time series data from 1971 up to 2005 with reference to Pakistan. The main focus of the study is on the inflation-inequality puzzle but other control variables are also included in the model that affect income distribution. We have utilized the most advanced technique FMOLS (Fully-Modified Ordinary Least Square) for long run and ECM (Error Correction Model) for short run dynamics. Our findings suggest that inflation is progressive in the case of Pakistan but with low magnitude. There is also a prevalence of a U-shaped relationship between inflation and income inequality in non-linear or non-monotonic phenomenon, but it is insignificant. Per capita income deteriorates income distribution, and seems to provide gains to non-poor individuals in the economy. Remittances as share of GDP, and human capital, also appear to increase income inequality in both periods but large size of the government seems to worsen income distribution in the long run. International trade and income inequality are positively correlated that confirms the existence of Leontief paradox in Pakistan not only in short run, but also in long run. Financial development declines income inequality insignificantly. Inverted U-shaped curve (Lafer-Curve) indicates an association of trade and income inequality in non-linear fashion insignificantly. This effort provides some new insights for policy makers and development planners in Pakistan. Keywords: Inflation; inequality; fully modifed ordinary least square; Pakistan.