Poor Households and the Weight of Inflation

Jan Schulz () and Leonhard Ipsen ()

No 106-2024, FMM Working Paper from IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute

Abstract: Public opinion and the perceptions of poorer households consistently indicate that the poor are most exposed to inflation. Meanwhile, the empirical literature on income-dependent inflation inequality remains ambiguous. In this paper, we explore two different explanations for this inflation-inequality puzzle. First, we examine the role of sectorial heterogeneity in modulating the impact of cost-push shocks on households. An Input-Output analysis for 21 EU countries within the global production network shows the income-dependent impact of a price shock to be highly contingent on the sector of origin. While these findings suggest a partial explanation for the ambiguous results on inflation inequality, they do not point to a consistent overexposure of lower-income households. As a second explanation, we propose the income-weighting of price shock effects as opposed to the conventional expenditure-weighting. This approach considers the share of income allocated to consumption and thus directly affected by a change in prices. Using a utility framework, we demonstrate that under bounded rationality the decline in utility is indeed proportional to the average propensity to consume times the change in prices. Introducing these income-weights in our empirical analysis, we find lower-income households to be disproportionally affected by every sectorial price shock, fully explaining the inflation-inequality puzzle.

Keywords: Inflation; Input-output Analysis; Europe; Inequality (search for similar items in EconPapers)
JEL-codes: C15 C67 D31 D90 E31 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2024
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