Who is hurt most by inflation?
Tyler Cowen has a new Bloomberg column that starts off as follows:
With inflation now rising faster than at any time in the last four decades, economists are debating which group suffers more from inflation, the poor or the rich. This kind of economy-wide question is not easy to answer, especially when rates of inflation have been so low in recent times and hard data are scarce. Nor is it obvious how exactly to compare the losses to the poor to the losses to wealthier groups. Nonetheless, the arguments suggest that the poor are likely to take a beating.
Tyler’s right that this is not an easy question to answer, as the term ‘inflation’ applies to many different and somewhat unrelated phenomena. Thus an adverse supply shock that raises the price of specific commodities while reducing real GDP is often called “inflation”. Inflation is also the outcome of a positive demand shock that raises a broad range of prices while also increasing real GDP. Not surprisingly, the welfare effects of a shock that decreases real GDP will not be the same as the welfare effects of a shock that increases GDP.
And that’s just the beginning. One must also distinguish between short and long run effects. I believe that a highly expansionary monetary policy raises welfare in the short run, helping both the poor and the rich (albeit for different reasons–less unemployment for the poor and higher real asset prices for the rich.) And yet I oppose such policies because I believe the long run effects are quite negative, and more than offset the positive short run impact. More specifically, highly expansionary monetary policies can create an unstable economy, a cycle of boom and bust. They also lead to higher real tax rates on investment income, slowing economic growth.
The poor is the socioeconomic group that finds it hardest to purchase a home, and real estate seems to be one of the best inflation hedges. U.S. real estate prices have been on a tear for some time, including through the recent inflationary period.
Rents are rising at a rapid clip, due to the mix of rising demand and bottlenecked supply. The biggest losers there will be the poor.
This is all true, but a word of caution. While real estate is an inflation hedge, I doubt the recent increase in real estate prices has much to do with that fact. Rather the price of homes has become increasingly expensive during the 21st century due to a combination of NIMBYism and low real interest rates. The low real interest rates do not necessarily affect monthly rents, but NIMBYism and tighter regulation on mortgage lending to the working class do push up rents.
Certainly real estate is a significant part of “inflation” in an accounting sense. But in my view it makes more sense to analyze specific products such as housing in a microeconomic context. How are the poor affected if the real or relative price of housing rises?
In other words, one reason why Tyler’s question is hard to answer is that it is actually multiple questions:
1. What is the impact of an expansionary monetary policy on the poor and rich? Is the effect different in the short and long run? Does the effect depend on whether the policy was anticipated or unanticipated? Does it depend on whether the tax system is indexed to inflation?
2. What is the effect on the poor of NIMBY regulations that make it more difficult to built homes?
3. What is the effect on the poor of regulations that restrict health care production, making health care more expensive?
4. What is the effect on the poor of a decision by OPEC to reduce oil production?
And I could name 100 more such questions. These all get lumped together as “inflation”, and in an accounting sense they are a part of the inflation process. But they are radically different questions.
Here are two somewhat more clearly defined questions:
1. Would the poor in America benefit (on average) if the Fed announced today that its monetary policy going forward would be slightly more contractionary than currently expected by the markets?
2. Would the poor in America benefit (on average) if the Fed announced today that its monetary policy going forward would be much more contractionary than currently expected by the markets?
I believe the answer to the first question is yes and the answer to the second question is no. I’d give the same two answers if you asked me about the middle class. And I’d give the same answers if you asked me about the rich.
PS. Here’s an analogy. If patient asked a doctor what was the impact of a fever of 101.4 degrees, the doctor might respond by first ascertaining the cause of the fever. Inflation is sort of like a fever, evidence of certain underlying conditions affecting the economy. But the focus should be on the underlying conditions, not the symptom.
PPS. Shorter version of post: Never reason from a price level change.
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