Cheapflation And The Rise Of Inflation Inequality

18th August 2024

The Institute for Fiscal Studies report Cheapflation and
the rise of inflation inequality looks at the problems.

Using household scanner data for fast-moving consumer goods, we show that this was accompanied by historically high rates of inflation inequality.

The period 2021-2023 saw prices rising at historically high rates. Using household scanner data for fast-moving consumer goods, we show that this was accompanied by historically high rates of inflation inequality.

We document systematic increases in the relative prices of cheaper product varieties (‘cheapflation') over this period, and show that this drove differences in household-specific inflation rates.

After accounting for substitution effects and adjusting for non-homothetic preferences, we show that the inflation-income gradient translated into a similar gradient in the cost of maintaining pre shock living standards.

We also show evidence, using an earlier exchange rate shock that followed the UK's vote to leave the European Union, that differential proportional pass-through of cost shocks is likely to be a factor driving cheapflation.

www.kelvinprobe.com
Pdf 46 Pages

Note
The report contains some formulas but if you skip over these it is easy to understand. However if you do not want to plough through it here are the conclusions -
Conclusion
We show that the 2021-2023 cost-of-living crisis entailed a steep gradient in householdlevel inflation rates, unprecedented in the UK in recent times. The gradient is driven by differences in consumption baskets across products within narrowly defined product categories, underlining the importance of using granular data to study inflation
inequality (Jaravel (2021)) and in answer to calls for income-group specific inflation indices (Klick (2021)).

The inflation inequality is driven by a novel pattern of cheapflation; higher proportional prices rises for lower quality procomprise a relatively high share of less well-off households' consumption baskets.

Households responded both to relative price changes and to changes in their living standards, which led them to switch to lower quality, high price growth products.

Therefore both substitution effects and preference non-homotheticities played an important role in driving expenditure switching over this period. After accounting for them we find the gradient in the cost of maintaining living standards at their
pre-inflationary shock level exhibits a similar significant gradient.

The causes of differential price growth across the quality ladder over 2021-2023 are likely to be complex and an important area for future research. Using the previous exchange rate shock around the Brexit vote, we show exchange rate changes were passed through more in proportional terms to the prices of cheaper products, indicating that higher proportional pass-through of marginal cost shocks is likely to be part of the story.

Recent evidence suggests that the immediate post COVID-19 pandemic period bore witness to cheapflation in a number of countries (Cavallo and Kryvtsov (2024)).

This raises the possibility that cheapflation has fueled inflation and cost-of-living inequality in many countries. It also remains to be seen whether this pattern will persist in periods of more general price stability. Both topics are importance avenues for future research.