Deflation by Expenditure Components: A Harmless Adjustment?

47 Pages Posted: 6 Jun 2023

See all articles by Nicola Amendola

Nicola Amendola

University of Rome Tor Vergata - Department of Economics and Finance

Giulia Mancini

Università Degli Studi di Sassari

Silvia Redaelli

World Bank

Giovanni Vecchi

University of Rome Tor Vergata - Department of Economics, Law and Institutions

Date Written: June 5, 2023

Abstract

We investigate the effect that seemingly minor features of the implementation of cost-of-living adjustments have on the distribution of household expenditures, by developing an analytical framework that is consistent with standard consumer theory, and mindful of data limitations faced by practitioners. The main result is at odds with common sense: even when multiple price indices are available (e.g. a food and a non-food CPI), it turns out that using a single price index (e.g. the total CPI), to adjust the consumption aggregate is recommended. The practice of adjusting subcomponents of consumption separately (food with a food index, non-food with a non-food index) can lead to a systematic bias in the welfare measure, and consequently in poverty and inequality measures. Using Iran’s 2019 Household Expenditures and Income Survey, we find that the bias manifests as a systematic underestimation of urban poverty, and overestimation of rural poverty.

Suggested Citation

Amendola, Nicola and Mancini, Giulia and Redaelli, Silvia and Vecchi, Giovanni, Deflation by Expenditure Components: A Harmless Adjustment? (June 5, 2023). CEIS Working Paper No. 558, Available at SSRN: https://ssrn.com/abstract=4469272 or http://dx.doi.org/10.2139/ssrn.4469272

Nicola Amendola (Contact Author)

University of Rome Tor Vergata - Department of Economics and Finance ( email )

Rome
Italy

Giulia Mancini

Università Degli Studi di Sassari ( email )

Piazza Università 21
Sassari, Sadinia
Italy

Silvia Redaelli

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Giovanni Vecchi

University of Rome Tor Vergata - Department of Economics, Law and Institutions ( email )

Via Columbia, 2
Rome, Rome 00133
Italy

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