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: Suggested Citation