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Inflation for Whom?

Summary:
EDIT: I am getting some very confused readers, who note that historically rent, education and health care have historically risen in price faster than most goods, while in this post I’m saying they are rising more slowly. The original post, should have, but did not, make clear that the pattern of price changes over the past year or so is quite different from what we are used to. That said, this is not all about the pandemic. As I did note, inflation in education has been slowing for a long time; health care inflation has fallen dramatically during the pandemic but was also slowing before that, arguably thanks to the ACA. But the key point is that I am not saying that poor people face lower inflation in general; I’m saying this is a distinct feature of the inflation we’re experiencing

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EDIT: I am getting some very confused readers, who note that historically rent, education and health care have historically risen in price faster than most goods, while in this post I’m saying they are rising more slowly. The original post, should have, but did not, make clear that the pattern of price changes over the past year or so is quite different from what we are used to. That said, this is not all about the pandemic. As I did note, inflation in education has been slowing for a long time; health care inflation has fallen dramatically during the pandemic but was also slowing before that, arguably thanks to the ACA. But the key point is that I am not saying that poor people face lower inflation in general; I’m saying this is a distinct feature of the inflation we’re experiencing now.

A point I’ve been emphasizing about inflation (see here and here) is that it is just an average of price changes; it doesn’t have any independent existence.

One implication of this is that there is not, even in principle, a true inflation rate. Pick any basket of goods and measure their prices over time; that is an inflation rate. The “all urban consumers” basket used by the BLS for the headline CPI inflation rate is a useful benchmark, but it’s just one basket among others. Any individual household or subgroup of households will have its own consumption basket and corresponding inflation rate.

Because a small number of items have gone up in price a lot recently, the average price increase in the CPI basket is greater than increase in wages over the past year. In this sense, real wages have gone down. I am not convinced this is a meaningful statistic. For one thing, car prices are almost certain to come back down over the next year, once the current semiconductor bottleneck is relieved and manufacturers ramp up output. Wage gains, on the other hand, have a lot of inertia. This year’s wage gains are likely to continue; certainly they will not be given back.

But there’s another reason the “falling real wage” claim is misleading. When price increases are concentrated in a few areas, the inflation rate facing people who are buying stuff in those areas will be very different from the rate facing those who are not. Most Americans do buy a car every few years, but relatively few need to buy a car right now.1 And even averaged over time, different groups of people spend more or less on cars relative to other things. The same goes for other categories of spending.

The BLS’s Consumer Expenditure Survey (CEX) tries to measure the distribution of consumption spending by different demographic groups. In principle, you could construct a separate CPI for each group, like CPI-E the BLS reports for elderly households. (For what it’s worth the CPI-E increased by 4.8 percent over the past year, a bit slower than the headline rate.) In practice the challenges in doing this are formidable — for the headline measure weights can be based on retail sales, but the weights for demographic group have to be based on household surveys, which are slower and much less reliable. (I have some discussion of these issues in Section 7 of this paper.) Still, the CEX can give us at least a rough sense of the difference in consumption baskets and inflation rates across different groups.

It’s particularly interesting to look at consumption baskets across income groups. One of the central arguments for running the economy hot is that it tends to compress wages. From this point of view, an increase in prices paid disproportionately by lower income households is more concerning than a similar aggregate increase in prices paid more by the better off.

For this post, I chose to focus on the consumption basket of households with pre-tax income below $30,000 a year — about one quarter of the population.

In the table below, I show 20 items, accounting for almost 95% of the CPI basket. The first column shows its share of the CPI-U basket, taken from the most recent CPI Table 2. The second column shows the difference between the weight of the item in consumption by households earning less than $30,000 and its weight in total consumption.2 So a positive value means something that makes up a larger share of consumption for households with incomes under $30,000 than of consumption for the population as a whole. This comes from the most recent Consumer Expenditure Survey, covering July 2019 through June 2020. The third column shows the price change of that item from July 2020 to July 2021, again from CPI Table 2. The items are ordered from the ones that make up the largest relative share of the consumption basket for low-income households to the ones that make up the smallest relative share. So it gives at least a rough sense of the different inflations experienced by lower versus higher income families.

Expenditure Category Overall share (CPI) Relative share, income <$30k (CEX) Inflation, July 2020-July 2021 (CPI)
Rent of primary residence 7.6 8.3 1.9
Food at home 7.6 2.4 2.6
Electricity 2.5 1.5 4
Medical care services 7.1 1 0.8
Medical care commodities 1.5 0.35 -2.1
Recreation commodities 2.0 0.35 3.2
Water and sewer and trash collection 1.1 0.3 3.7
Education and communication services 6.1 0.2 1.2
Motor fuel 3.8 0.2 41.6
Utility (piped) gas service 0.7 0.2 19
Apparel 2.7 0.2 4.2
Motor vehicle parts and equipment 0.4 0.05 4.3
Fuel oil and other fuels 0.2 0.05 30.9
New vehicles 3.7 -0.15 6.4
Transportation services 5.3 -0.15 6.4
Lodging away from home 1.0 -0.3 21.5
Used cars and trucks 3.5 -0.3 41.7
Alcoholic beverages 1.0 -0.3 2.4
Food away from home 6.2 -0.35 4.6
Recreation services 3.7 -0.6 3.7
Household furnishings and supplies 3.7 -0.7 3
Owners’ equivalent rent 22.4 n/a3 2.4

As you can see, the items that are increasing at less than 2 percent a year — highlighted in blue — are all things disproportionately consumed by lower-income households. Rent, in particular, makes up a much higher share of spending for low-income households. Rent growth slowed sharply during the pandemic and, unlike many other prices, it has not so far accelerated again. Rent growth over the past year is about half the average rate in the three years before the pandemic.

Medical goods and services also make up a larger share of spending for lower-income households; prices there have grown slowly or income cases actually fallen over the past year. Prescription drug prices, for example, fell by 2 percent over the past year. Finally, education services, including childcare, have pulled inflation down over the past year, rising by about 1 percent (college tuition was flat.) Education inflation has been slowing for a long time — a trend I don’t recall seeing discussed much — but it slowed even more during the pandemic. Education and childcare make up a slightly higher fraction of spending for low-income households than for others.

On the other side, almost all the sectors where inflation is notably high — highlighted in red — make up a larger share of spending for higher-income households. Lodging away from home, for example, where prices are up over 20 percent, makes up less than 1 percent of the consumption basket for households with incomes under $30,000, but 2.5 percent of the basket for households with incomes over $200,000. Transportation services, food away from home, and new and used cars, which account for  the majority of non-energy inflation, are also disproportionately consumed by higher income households.

In general, it seems clear that lower-income households are facing less inflation than higher income ones. The biggest price increases are in areas that are disproportionately consumed by higher-income families, while several of the most important consumption categories for lower-income families are seeing prices rise more slowly than before the pandemic. Any discussion of “falling real incomes” that ignores this fact is at best incomplete.

There is, of course, one big exception: energy. Gasoline especially, but also electricity and heating gas, are seeing big price increases and make up a larger share of consumption for lower-income families. And unlike auto purchases, energy consumption can’t be postponed. If you want to tell a story about higher prices eating up wage gains, it seems to me that energy is your best bet.

Except, of course, that these are prices that we want to see rise, if we are serious about climate change. Many of the same people fretting about inflation eroding real wages, are strong supporters of carbon taxes or permits. If you think a goal of policy is to raise the relative price of fossil fuels, why object when it happens via the market?

At the end of the day, perhaps the current debate about inflation and real wages doesn’t belong in the macroeconomics box at all, but in the climate box. The difficult problem here is not how to keep demand strong enough to raise wages without also raising prices. The price spikes we’re seeing right now are mainly about short-term supply constraints. I am confident that prices for autos and many other goods will  come back down or at least stabilize over the next year, even if demand remains strong. The really difficult problem is how we make the transition away from fossil fuels without unacceptably burdening the people who are currently dependent on them.

  1. Another issue is that the pandemic and reopening have shifted the mix of consumption faster than the official weights are updated. One attempt to correct for this finds that the CPI was understating inflation during the pandemic, but has been overstating it since April.
  2. This is the difference between the overall CEX weight and CEX weight for households with incomes under $30,000. You can’t directly compare weights between the CPI and CEX.
  3. Because owners’ equivalent rent is an estimate of what the rent would be for a similar unit, and not an actual outlay, it can’t be measured in surveys.
About JW Mason
JW Mason
Assistant professor of economics at John Jay College - CUNY, and fellow at the Roosevelt Institute. RT = Read This

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