Non-homothetic Demand Shifts and Inflation Inequality

Jake D. Orchard
Additional contact information
Jake D. Orchard: https://www.federalreserve.gov/econres/jake-d-orchard.htm

No 2025-085, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper shows that adverse macroeconomic shocks systematically increase inflation for low-income households relative to high-income households. I document two key facts: (i) during every U.S. recession since 1959, aggregate spending shifts toward products disproportionately purchased by low-income households (necessities); and (ii) relative prices of necessities rise during recessions. These patterns can be explained by a model with non-homothetic demand and a concave production possibility frontier: shocks that reduce expenditure induce households to reallocate spending from luxuries to necessities, raising their relative prices. I empirically show that this mechanism operates for both demand and supply shocks, using monetary policy and oil price news shocks. Incorporating this mechanism into a quantitative model reproduces most of the variation in necessity prices and shares from 1961 to 2024. The model shows that the fall in expenditure due to a recessionary shock similar to the Great Recession leads inflation to increase by more than 1.5 percentage points for low-income households relative to high-income households. The results suggest that low-income households are hit twice by adverse shocks: once by the shock itself and again as their price index increases relative to that of other households.

Keywords: Inflation; Non-homotheticity; Real income inequality; Business cycle (search for similar items in EconPapers)
JEL-codes: D12 E30 (search for similar items in EconPapers)
Pages: 77 p.
Date: 2025-09-19
New Economics Papers: this item is included in nep-mon
References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.federalreserve.gov/econres/feds/files/2025085pap.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2025-85

DOI: 10.17016/FEDS.2025.085

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ; Keisha Fournillier ().