Cover image’s Credits: Euranet Plus, Eurostat data – October 2022

The Eurozone has experienced an unprecedented surge in inflation since the onset of the Covid-19 pandemic. While the composition of inflation during that period was very unique and deserves critical analysis on its own as well as together with policy measures applied to tackle it, the socioeconomic effects are different from former inflationary periods and demand critical examination too. Especially the redistributive effects following the unique composition are mostly overlooked by politics and show a significant shift of wealth from the poorest to the wealthiest parts of many European societies.

Inflation affects households differently based on their income and expenditure composition. Lower-income households tend to spend a higher proportion of their income on necessities such as rent, food, and utilities. Consequently, they are disproportionately impacted when prices of essential goods and services increase relative to average inflation rates. In the recent inflationary period, it was especially these necessities with energy and food prices increasing stronger than ever seen before. On top of that, low-income low-wealth households often already consume the relatively cheapest products and thus have no leeway to save money by choosing more basic instead of premium products.

Euro area consumption baskets by income quintile (share of total expenditure, scaled to 1,000)

Income sources play a crucial role in determining how inflationary shocks are transmitted to households. While wages (and social benefits) constitute the primary income sources for lower- and middle-income households, higher-income households derive a significant portion of their income from capital income. In the current environment, many firms have been able to increase profit margins leading to the redistribution of profits as dividends, thereby benefiting households with equity holdings. This effect is especially strong when inflation results from price increases of commodities (i.e., energy and food), where price increases substantially flow to the original commodity owners and their value chain in the form of profits. In contrast, in the case of services, price increases substantially flow to workers through wages.

Low-wealth low-income households typically have thinner savings buffers, making them more susceptible to financial distress and leaving them with less room to absorb cost increases when facing adverse economic shocks. Neoclassical economic theory suggests that this should be offset by the relative price decrease of nominal denominated debts (in other words: with persistent inflation, it becomes cheaper to buy goods on credit as income will increase with inflation over time to offset). This typically applies to mortgages for households that buy a house: the price of the house should increase with inflation, so the value of the debt decreases relatively to the value of the house over time. However, this only comes into full effect if interest rates do not change so there is no extra burden on current costs. As interest rates were raised strongly by the ECB, annual payments on debt have become much more expensive and simultaneously, banks have been slow at increasing interest earned on deposits. To this extent, even the increase of real assets, which would for example help middle class households buying homes, has not really dampened the increase in inequality this time on a broad level yet.

On a policy recommendation level, all this evidence points to two main areas of needed response. First, politics should address the reasons underlying such heterogeneous inflation mix and try to implement measures targeting specifically price increases of necessities. This is because these increases have only little regulating effect especially on poorer households as they cannot truly change the consumption of these, by definition, necessary goods. Second, politics should design policies that specifically decrease the recent redistributive effects, possibly by one-off taxes e.g. on real assets such as companies and infrastructure that have abnormally benefited from the inflation.

In conclusion, the recent surge in inflation in the Eurozone has brought to the forefront the redistributive effects of inflation. Understanding how inflation impacts different socio-economic groups is crucial for crafting effective policy responses to mitigate its adverse effects on the most vulnerable households. On top of that, policymakers should address how the recent inflationary period represented a redistribution of wealth from the poorest to the richest parts of society and implement measures to prevent that from happening again.

BIBLIOGRAPHY

Alina Bobasu, Virginia di Nino, Chiara Osbat, The impact of the recent inflation surge across households (2023)

Nicola Curci, Marco Savegnago, Giordano Zevi, Roberta Zizza, The redistributive effects of inflation: A microsimulation analysis for Italy (2023)

Philip Schnorpfeil, Michael Weber, Andreas Hackethal, Households’ response to the wealth effects of inflation (2024)