The Latest, Greatest, Idea – Inflation Inequality

So, the idea is that we’re underestimating how many poor people there are because poor and rich face different inflation rates. Yet we use the common inflation rate – the CPI – to upgrade benefits and the poverty line. Clearly, this is about the US and nowhere else, given that everyone else uses a percentage of median income as the poverty line:

But just how much bigger the percentage of people living in poverty is becoming may have been underestimated by the official census, according to a new report by the Center on Poverty and Social Policy at Columbia University.

While all official statistics apply the same rate of inflation to the income of people living in all income brackets, evidence highlighted by the study suggests that inflation is much higher for people at the lower end of the income scale. This is a phenomenon that Xavier Jaravel, a researcher at the London School of Economics and one of the author of the report, calls “inequality inflation.” For the bottom 20%, Jaravel has found, inflation is 0.44 percentage points higher than it is for the top 20%.

Hmm, well, mebbe.

It is widely recognized that income inequality has skyrocketed in recent decades. Incomes at the top of the
distribution have grown rapidly, far outpacing income growth at the bottom. Recent research also shows that
prices have risen more quickly for people at the bottom of the income distribution than for those at the top
—a phenomenon dubbed “inflation inequality.” An implication of this new finding is that we may be underestimating income inequality and poverty rates in the United States—two national statistics that rely heavily
on the annual inflation rate as part of their calculation. In this brief, we utilize an adjusted inflation index that
accounts for inflation inequality across the income distribution and re-estimate recent trends in poverty and
income inequality from 2004 to 2018. Our adjusted inflation index indicates that 3.2 million more people are
classified as living in poverty in 2018, and that real household income for the bottom 20 percent of the income distribution actually declined by nearly 7 percent since 2004. These results show that inflation inequality significantly accentuates both the incidence of poverty and income inequality.

Well, actually, no. We can state that this finding is wrong. How wrong is another matter, but it is wrong. It’s published in a very heavyweight journal and yet, when put to this use, it is still wrong.

So, what is actually wrong with it?

He looks at prices. Great, that’s what we hope he’d do of course. But he looks at the prices of goods. Specifically, retail bought goods using barcodes and the Nielsen numbers. Which means that our finding of the different inflation rate – he says it’s about 0.44% higher for the bottom 20% than the top 20% – applies to goods bought retail with barcodes recorded by the Nielsen numbers.

OK, fine with that. But that doesn’t mean that the inflation rate faced differs by that much. Because goods bought retail are not even the majority of spending let alone all of it.

I’ve never known let alone can remember whether housing costs are part of the US CPI calculation. But I do know that services are. And we only need one of those to make the point, health care insurance.

The bottom 20% of US households – OK. largely, not entirely – face no health care cost inflation at all. Because their insurance is provided through Medicaid. They simply don’t face prices, let alone inflation, in this area. The top 20% do of course. Even if it’s employer paid that’s a cut of their compensation if not wages. So, recorded incomes decrease by whatever health care insurance inflation there is.

Again, this ain’t true but it’s not far off real numbers. A household’s health care insurance is 10% of income, inflation in health care insurance most certainly has been 10% a year at times. To repeat, I don’t pretend that these are real numbers, they’re just to make the math easy. At which point that top 20% household is facing a 1% a year inflation rate solely from health care insurance. Something that the bottom 20% household doesn’t face.

This not being recorded in the above calculation because it’s looking at goods and goods only, bought retail and bought retail only.

And it’s 1% – rather more than the 0.44%.

We also have theory as a guide here. Baumol. Services will become more expensive relative to manufactures over time, as real incomes rise. Higher income households consume more services in their consumption basket than lower income ones do. Therefore recording goods inflation only doesn’t tell us the different inflation rates faced by households at different income levels.

How much it doesn’t tell us is way above my pay grade and intellect level. But we do know that we cannot project goods only inflation rates onto the general inflation rate across income levels. Which is exactly what is being done here.