Inflation may be coming down but its unequal effects can still have a big impact on wellbeing

Inflation is coming down across developed economies, although not as much as governments and central banks would like. The latest figures tracking UK inflation show prices rose by 7.3% in the year to June 2023, down from 7.9% in May, but still well above the government’s official target of 2%. It’s slowing even more in other major economies including the US and Europe but, again, remains higher than desired.

Price hikes hurt everyone, but research into inflation inequality shows the effects are more pronounced for some people.

Imagine the following scenario. You commute to work by car and you realise that your petrol bill is 10% higher than last year. Your workplace hasn’t changed location, your car hasn’t changed, your consumption hasn’t changed, but prices have. Annoying, isn’t it?

When you share your frustration with your sister, she might tell you that things aren’t so bad, but she commutes by train. Your dad may say that he hasn’t noticed a change, but he’s retired and rarely drives. A friend could tell you that her situation is even worse, since her commuting distance is double yours.

Who’s right about price inflation? Everyone. The point is that inflation is not the same for everyone.

Over the same period, and in the same country, different people experience different inflation rates. This is an acknowledged economic fact known as inflation inequality.

In theory, people who are the most exposed to inflation should be the ones who endure a larger wellbeing loss as prices rise. In a recent study, I showed this, using data from France’s official consumer confidence survey.

Economists have a range of options available to measure wellbeing. Mostly, these can be divided in two categories: objective outcomes (typically, how much people earn/spend) and subjective outcomes (how people feel).

Subjective outcomes are especially useful to measure when economic factors have psychological effects that are not properly captured by earning, spending and saving alone. Inflation is a good example of this.

Say your rent increases by £200 a month just as your salary increases by the same amount. From an accounting point of view, your situation has not changed much, but it still feels aggravating. There is a well-documented psychological reason for this: humans detest losses.

And this is how inflation feels – losing purchasing power, for no apparent reason. This might help explain why inflation has for a long time been one of the most hated economic phenomena in western countries, even during periods of low price growth.

The satisfaction gap

Research published two decades ago was the first to show that, when average prices accelerate, people tend to declare lower life satisfaction. Since then, several studies have confirmed this finding. But these studies have focused on a macroeconomic concept of inflation, as if everyone was experiencing the same inflation rate. What about inflation inequality?

Assessing the impact of inflation inequality on people’s wellbeing involves complex measurement issues. Ideally, as a researcher in economic psychology, I would like to monitor a large group of individuals and observe their purchasing habits, the prices they pay for goods and their level of satisfaction.

However, current data collected by retailers and statistical institutes is not sufficient for this purpose – not least because they do not ask people about their wellbeing.

Price shock.
PERO studio/Shutterstock

To get around this problem, I have used two complementary approaches in my research. I examined consumers’ opinions regarding the changes in prices over the past year as reported in the consumer confidence survey. Some people experience higher inflation rates than others and asking them how much prices have changed is a natural way to learn about these differences.

Since answers will only be an approximation of actual inflation rates, I applied some behavioural and statistical techniques to account for noise and biases.

I then constructed a dataset that includes details about consumption habits and subjective satisfaction. This helped me compare groups of people based on their modes of transportation – car commuters versus those who use bikes or public transport, for example – and investigate how they reacted to fluctuations in the price of petrol.

My two analyses reveal that inflation inequality does matter. If someone reports a one percentage point higher inflation rate compared to another consumer, there is a significant difference in their satisfaction levels. My research shows that this satisfaction gap is larger than the gap associated with a 1% difference in income.

These findings were confirmed when comparing different groups of consumers. Those who commute by car tended to report higher levels of inflation and lower satisfaction with their living standards when the price of petrol increased, compared to those who commuted by other means.

These differences were observed even in a context of general price stability, when average inflation was particularly low.

Thinking more about inflation inequality

Inflation inequality does not typically receive much attention. When prices remain stable, inflation inequality is relatively modest, as is the impact on wellbeing.

But as inflation accelerates, so does the inequality associated with it. For instance, between March 2020 and March 2022, the average inflation gap reported by French consumers more than tripled. This is likely to be the case elsewhere too, at least in the many regions that have faced peak levels of inflation in the last year and a half, such as the UK.

Inflation inequality can induce a sense of frustration, helplessness and injustice, and overlooking the psychological effects would leave an incomplete picture of how inflation affects our lives. It has been shown that these effects can also worsen existing income inequality, by disproportionally affecting the lowest earners.

This is why measuring inflation inequality is both important and urgent for a policy agenda that places citizens’ wellbeing at its centre, especially during a cost of living crisis.

by : Alberto Prati, Assistant professor, UCL

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