The impact of the recent rise in inflation on low-income households

Prepared by Evangelos Charalampakis, Bruno Fagandini, Lukas Henkel and Chiara Osbat

Published as part of the ECB Economic Bulletin, Issue 7/2022.

The effects of the recent increase in euro area HICP inflation significantly differ for low and high-income households. This box explores how recent high inflation levels are affecting low-income and high-income households differently in two main areas: their effective inflation rate due to different spending patterns, and their ability to buffer cost of living increases through savings or borrowing. The gap between the effective inflation rates experienced by those in the lowest and highest income quintiles, calculated using data on household consumption patterns, is at its greatest since 2006. Additionally, low-income households consume a larger share of their income, save less and are more liquidity-constrained than high-income households; they therefore have less room to buffer sharp increases in their cost of living through savings.

Consumption baskets vary across income groups, with low-income households spending proportionally more on essentials. Low-income households in the euro area spend a higher proportion of their total consumption expenditures on food, electricity, gas and heating and a lower proportion on transport^[1], recreation, restaurants and household goods relative to high-income households (Chart A). The income-specific consumption baskets reported in the Eurostat Household Budget Survey (HBS) allow effective inflation rates to be calculated by income quintile. As “owner-occupied housing costs” are not covered by the HICP, both owner-occupied housing costs and rents were excluded from the calculations of quintile-specific effective inflation rates in this box to avoid distortions due to composition effects in measuring the cost of housing across income classes.^[2]

Chart A

Euro area consumption baskets for 2015 by income quintile

(share of total expenditure, scaled to 1,000)

The difference between the effective inflation rate in the lowest and highest income quintiles is currently at its greatest since 2006. Between 2011 and November 2021, the gap has mostly remained small, fluctuating between -0.25 and 0.25 percentage points, which also reflected the low inflation environment. However, it increased sharply from 0.1 percentage points in September 2021 to 1.9 percentage points in September 2022 (Chart B).^[3] This inflation gap between poorer and richer households is mainly driven by energy and food prices. Decomposing the inflation gap, “electricity, gas and other fuels” and, increasingly, food prices are the main drivers of the higher inflation faced by lower-income households. However, the energy price increase embedded in higher transport prices (which includes petrol and diesel, but also flights for tourism) mitigates this gap (Chart C). In addition, richer households tend to consume more expensive varieties of items within the same goods category (for example, buying branded products instead of cheaper white-label products). These differing shopping behaviours also highlight that high-income households have another avenue available to reduce their spending – by substituting expensive products with cheaper alternatives – whereas low-income households tend to already buy cheaper varieties and are thus less able to buffer the impact of inflation through substitution. However, the calculations in Chart B do not account for these substitutions.

Chart B

Inflation difference between the lowest and highest income quintile households in the euro area

(percentages)

Chart C

Decomposition of the inflation difference between the lowest and highest income quintile households

(percentages)

Low-income households also have less room to buffer sharp increases in their cost of living through savings. They tend to consume a larger share of their income, save less and face liquidity constraints more often than high-income households. Data from the 2017 wave of the Household Finance and Consumption Survey (HFCS) show that households at the bottom of the income distribution have the lowest median value of liquid financial assets, whereas households in the top income percentiles have the highest (Chart D, panel a). This means that low-income households have a lower capacity to absorb sharp, inflation-driven increases in living costs. In addition, the median saving rate as a percentage of household disposable income increases in higher income quintiles. Low-income households dissave, with a median saving rate of -6.4% at the bottom income quintile, whereas those in the top income quintile save 39.3% (Chart D, panel b).

Chart D

Liquid financial assets and saving rates of households in the euro area

a) Liquid financial assets

(x-axis: income percentiles, y-axis: median value of liquid financial assets in EUR thousands)

b) Saving rates

(x-axis: income quintiles, y-axis: saving rate as a percentage of disposable income)

The higher incidence of liquidity constraints experienced by poorer households is reflected in the rise in households expecting to make late payments on their utility bills. Evidence based on the ECB’s Consumer Expectations Survey (CES) indicates that, for the same increase in energy spending, the reduction in savings for households in the lowest income quintile is more than five or six times greater than for households in the highest income quintile.^[4] In this respect, a salient piece of information from the CES is that the proportion of consumers who expect to be late in paying their utility bills has risen more for low-income households than for high-income households since April 2020 (Chart E). This could mean that the financial stability of low-income households is even more threatened, given the inflationary pressures on energy and food prices.

Chart E

Proportion of consumers expecting to pay utility bills late

(percentage of respondents)

Low-income households perceived the recent government measures aimed at easing the impact of higher energy prices as less adequate than high-income households did. The CES asked respondents to what extent they perceived these measures as sufficient to maintain their usual essential spending on goods and services. The average government intervention adequacy score was lowest for the bottom income quintile and highest for the top income quintile (Chart F). This may suggest that there is scope for more effectively targeting government measures towards low-income households.

Chart F

Perceived adequacy of government intervention to combat higher energy prices

(perceived adequacy of intervention on a scale of 0 to 10)

Inflation in energy and food prices has major distributional effects across low and high-income households. Low-income households are more vulnerable to these price shifts, as they spend a higher proportion of their total consumption expenditure on essentials such as food, electricity, gas and heating, tend to save less and are more subject to liquidity constraints. Euro area governments have taken measures to cushion the impact of recent inflation on households, but so far all income groups perceive these measures as insufficient – especially low-income households. This indicates that there is room for improvement in the way that support measures are targeted towards low-income households.