Cyclical Demand Shifts and Cost of Living Inequality

66 Pages Posted: 16 Feb 2022 Last revised: 28 Sep 2022

Date Written: September 27, 2022

Abstract

This paper studies how income level inflation rates vary over the course of the business cycle and documents two new facts: (1) during recessions prices rise more for products purchased relatively more by low-income households (necessities); (2) the aggregate share of spending devoted to necessities is counter-cyclical. I present a mechanism where adverse macroeconomic shocks cause households to shift expenditure away from luxuries toward necessities, which leads to higher relative prices for necessities. I embed this mechanism into a quantitative model which explains around half of the cyclical variation in necessity prices and shares. The results suggest that low-income households are hit twice by recessions: once by the recession itself and again as their price index increases relative to other households.

Keywords: inflation, non-homotheticity, real income inequality, business cycle, monetary policy

JEL Classification: E30, D12

Suggested Citation

Orchard, Jacob, Cyclical Demand Shifts and Cost of Living Inequality (September 27, 2022). Available at SSRN: https://ssrn.com/abstract=4033572 or http://dx.doi.org/10.2139/ssrn.4033572

Jacob Orchard (Contact Author)

Federal Reserve Board ( email )

Washington, D.C., DC

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