On the Distributional Results of Inflation and Inflation Stabilization

Marco Del Negro, Keshav Dogra, Pranay Gundam, Donggyu Lee, and Brian Pacula

This publish and the subsequent focus on the distributional results of inflation and inflation stabilization by way of the lenses of a theoretical mannequin—a Heterogeneous Agent New Keynesian (HANK) mannequin. This mannequin combines the options of New Keynesian fashions which have been the workhorse for financial coverage evaluation because the work of Woodford (2003) with inequality in wealth and earnings on the family stage following the seminal contribution of Kaplan, Moll, and Violante (2018). We discover that whereas inflation hurts everybody, it hurts the poor particularly. When the supply of inflation is a provide shock, combating inflation aggressively hurts the poor much more, nevertheless, whereas the alternative is true for demand shocks, as mentioned within the companion publish.

The Distributional Penalties of Financial Coverage Shocks

As a warm-up for the instinct of how the mannequin works, we begin by discussing the implications of contractionary financial coverage shocks, proven within the panel chart under. All through the publish, we use the HANK mannequin of Lee (2024), which we now have re-estimated utilizing information up till 2023:Q3. The purpose of the illustration is to indicate that the HANK mannequin options pretty normal responses for mixture variables: as nominal rates of interest improve by about 20 foundation factors on impression, each output and inflation fall, though the response of inflation (8 foundation factors) is small relative to the decline in output (greater than 50 foundation factors) highlighting the truth that the mannequin’s value Phillips curve is moderately flat. As financial exercise declines, the labor market worsens, with unemployment growing by 0.5 proportion level and actual wages declining barely.

Responses to Financial Coverage Shocks: Mixture Variables

The following chart shows the distributional penalties of the coverage shock, proven for households within the backside (B1 and B10) and high (T1 and T10) 1 % and 10 % of the wealth distribution, in addition to for the 5 quintiles (Q1 by way of Q5) of the wealth distribution. For every quantile of the wealth distribution, the impact of the coverage shock on the family’s welfare is measured in consumption equal phrases. That’s, every family belonging to a given quantile of the wealth distribution is requested how a lot consumption they’d be keen to forgo without end in an effort to keep away from the implications of the shock. The result’s then averaged throughout all households belonging to that quantile. The black strains measure the overall impact, whereas the coloured bars decompose the overall into parts as a consequence of 1) the rise in the actual rate of interest, and the decline in 2) labor earnings/wages, 3) earnings, 4) the job discovering charge, and 5) fairness costs (see Lee 2024 for particulars on how the decompositions are computed).

The Penalties of Financial Coverage Shocks Are Higher for the Poorest Households

The outcomes present that the poorest households undergo probably the most from the rate of interest hike. It is because the rise in charges will increase their monetary burden to the extent that they’re debtors. Furthermore, poor households’ main supply of earnings is labor, and the decline within the job discovering charge and the related improve in unemployment additionally damage them significantly. As we transfer up the wealth distribution, the impact of upper rates of interest switches signal: it’s near zero for households in the course of the distribution, as they’ve little wealth, and turns into constructive for wealthy households. Nonetheless, wealthy households additionally derive a considerable fraction of their earnings from earnings, and therefore they’re damage by the autumn in earnings. The truth is, the general impression of the shock is (inverted) U-shaped, with poor and really wealthy households being affected probably the most, though the underside 1 % of households are virtually twice as badly affected, in consumption equal phrases, as the highest 1 %.

This U-shaped sample is broadly per the rising empirical literature on the distributional impact of financial coverage shocks, which usually finds that expansionary shocks disproportionally profit low-income households, by growing their employment, and the very wealthy, by growing capital earnings, and vice versa for contractionary shocks. Utilizing Swedish information, Amberg et al. (2022) discover that expansionary shocks improve earnings probably the most for households within the highest and lowest earnings deciles; that is pushed by labor earnings for the bottom decile, and capital earnings for the best. Utilizing Norwegian administrative information, Holm et al. (2021) discover that contractionary financial coverage shocks lower consumption probably the most, at two- by way of five-year horizons, for households within the highest and lowest ranges of the liquid wealth distribution.

The Distributional Penalties of Inflationary Price Push Shocks

The chart under exhibits the responses of mixture variables to a one normal deviation inflationary price push shock. As normal within the New Keynesian literature, we mannequin this shock as a rise in corporations’ desired markup originating from a decline within the substitutability throughout merchandise. This fall in competitiveness results in costs rising. The crimson strains present the response underneath the estimated coverage response perform, and the blue strains present the responses obtained underneath another response perform that responds extra aggressively to inflation.

Responses to Price Push Shocks: Mixture Variables

Specializing in the crimson strains first, we see that the shock generates a large response of inflation, which rises by virtually 2 proportion factors, a 1.5 % decline in output, and a deterioration within the labor market, with unemployment rising multiple proportion level and actual wages falling by greater than 1 % after one 12 months and remaining depressed all through the forecast horizon. Whereas unemployment rises on impression and for the primary 12 months after the shock, it falls under regular state afterwards as a result of actual wages are low and corporations due to this fact discover it enticing to publish vacancies. Income decline on impression regardless of the upper desired markup due to the autumn in financial exercise. Income rebound quickly after, nevertheless, as a result of labor prices stay low. As we are going to see, the trail of earnings is essential for understanding the distributional impression of price push shocks. The blue strains present the impression underneath a extra aggressive response to inflation:  particularly, the coefficient on inflation φ_π within the Taylor-like response perform is raised from its estimated worth of 1.8 to 3.0. When coverage responds extra aggressively to inflation, inflation rises much less following the associated fee push shock, however the variations are small as a result of very flat Phillips curve. The output and labor market prices of containing inflation are conversely massive, with output falling by virtually 1 % greater than underneath the baseline rule and unemployment additionally rising by about 1 proportion level extra.

The following chart exhibits the distributional penalties of price push shocks. The message from the illustration is obvious: most households aside from the very wealthy lose considerably following a constructive price push shock. This loss is because of the truth that actual wages fall considerably within the aftermath of the shock and this hurts households, particularly if they’re hand-to-mouth. Arguably, this what Fed Chair Jerome Powell has been referring to in his press conferences over the previous couple of years, comparable to in June 2024, when stating that “excessive inflation imposes vital hardship because it erodes buying energy, particularly for these least capable of meet the upper prices of necessities….” Very wealthy individuals acquire from the shock, nevertheless. It is because they accrue all the additional revenue that the low price of labor implies after the primary few quarters.

The Distributional Penalties of Price Push Shocks

The chart under exhibits the distributional penalties of a stronger coverage response to price push shocks, that’s, the distinction between the distributional penalties of those shocks (computed as above) underneath φ_π equal to three and φ_π equal to 1.8. The lesson from this illustration is that if poor households are these which are most negatively affected by the associated fee push shock, they’re much more negatively affected if the central financial institution tries to combat inflation extra aggressively. It is because the extra aggressive coverage implies increased rates of interest, which hurts households which are in debt. Households with wealth conversely profit from the rise in actual charges. On the entire, these households will not be a lot affected by the extra aggressive coverage as their increased monetary earnings is offset by decrease labor earnings. Nonetheless, very wealthy households are additionally damage by the extra aggressive response to inflation as this reduces earnings.

The Distributional Penalties of a Stronger Coverage Response to Price Push Shocks

Summing Up

The distributional results of inflation, when the supply of inflation is a price push shock, are very uneven throughout the wealth distribution: the poor lose whereas the very wealthy profit. The supply of those losses and beneficial properties is the decline in actual wages which hurts hand-to-mouth households particularly, because it interprets virtually one to 1 right into a decline in consumption. On the similar time, the falling labor prices translate into will increase in company earnings and profit the very wealthy who obtain these earnings.

But whereas inflation hurts the poor probably the most when considered by way of a distributional lens, disinflationary insurance policies damage them much more. That’s, an aggressive coverage response to a price push shock results in an extra deterioration within the labor market along with increased rates of interest, which make debt dearer. If the Phillips curve is flat, as it’s on this estimated mannequin, the beneficial properties in taming inflation are restricted and don’t reverse these disadvantages for households on the backside of the wealth distribution.

Marco Del Negro is an financial analysis advisor in Macroeconomic and Financial Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.

Keshav Dogra is a senior economist and financial analysis advisor in Macroeconomic and Financial Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.

Pranay Gundam is a analysis analyst within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.

Donggyu Lee is a analysis economist in Macroeconomic and Financial Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.

Brian Pacula is a analysis analyst within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.

The best way to cite this publish:
Marco Del Negro, Keshav Dogra, Pranay Gundam, Donggyu Lee, and Brian Pacula, “On the Distributional Results of Inflation and Inflation Stabilization,” Federal Reserve Financial institution of New York Liberty Road Economics, July 2, 2024, https://libertystreeteconomics.newyorkfed.org/2024/07/on-the-distributional-effects-of-inflation-and-inflation-stabilization/.