Poor Households and the Weight of Inflation

Abstract

We argue that most of the existing literature on inflation inequality misses an essential source of disparity by focusing on differences in expenditures while ignoring the effect of a price change on the purchasing power of households’ incomes. As a remedy, we propose weighting price changes by income rather than by expenditure, as is commonly done. We theoretically derive why, under incomeweighting, lower-income households are disproportionately affected by any change in prices. This proposition is validated empirically for 21 EU countries using current sector-level input-output data. Our approach allows to reconcile the conflicting evidence in the literature on inflation inequality regarding structurally higher inflation perceptions and expectations of lower-income households. Ultimately, these findings call for a broad reassessment of current approaches to measuring inflation and income inequality