Does Inflation Really Hurt the Poor More than the Rich?

After being neglected for decades, income and wealth inequality are back at the center of economic discussions. Recent work by the IMF, renowned economists like Joseph Stiglitz (e.g. in his book “The Price of Inequality”), as well as the lively debate generated by Thomas Piketty’s “Capital in the Twenty-First Century” (including the discussion triggered just before the weekend by the FT about Piketty’s data on wealth inequality) are cases in point for that.

Renewed interest in the topic coincides with some sobering statistics: in many countries, inequality has reached levels that have been seldom observed in the past. In the United States, income inequality is now as high as it was in the 1930s.

Central banks are taking note of this development and start assessing the potential consequences of high inequality for the conduct of monetary policy. They are also asked whether their decisions have distributive effects and whether they have played a role in the increase of income and wealth gaps.

To get further insights and explore answers to these questions, the Council on Economic Policies (CEP) and the Federal Reserve Bank of Atlanta co-organized a 2-day workshop with academics and central bank professionals in April on “Monetary Policy and Inequality”.

One issue discussed at the event was to determine the impact of inflation, a core indicator of most central banks, on income inequality. Empirical research on the link between these two variables provides mixed results. Depending on the countries and the periods studied, researchers find either a positive or a negative correlation between them.

Building on the existing literature, we just published a working paper based on a sample of 10 OECD countries since 1970 that isolates the impact of inflation from other factors driving income inequality.

After accounting for the effect of other economic variables, we find a negative correlation between long term inflation and income inequality for low inflation rates. The results suggest that this link turns positive for higher inflation rates (i.e. above a threshold that we estimate at an inflation rate of 13%). These results are in line with other previous studies, which also find a U-shaped relationship between inflation and income inequality (Galli and van der Hoeven, 2001, Bulir, 2001, and Auda, 2010). However,  they contradict the strong and widespread belief that inflation hurts the poor more than the rich and thus increases income inequality.

The economic channels behind the negative correlation between inflation and income inequality are still unclear. How this negative correlation turns to be positive for higher inflation rates also remains to be better understood.

The research on these questions continues at CEP in collaboration with our network of academics and central bank practitioners. Our findings will be regularly published on this blog.