Rising Inflation Hurts Low-Income Americans the Most

By Michael Zhao

Fears of rampant inflation plastered newspaper headlines this past summer, as the latest Bureau of Labor Statistics (BLS) data showed that the Consumer Price Index (CPI), the traditional gold standard for measuring inflation, shot up by 5.4% in June in what has become the highest rate of year-to-year inflation recorded since 2008. The Fed has publicly stated that it expects inflation driven by temporary supply-chain bottlenecks to be largely confined to the short-term, and it has maintained its current policy of near-zero interest rates and bond purchases. But regardless of whether these price increases are transitory or turn out to last longer than the Fed has projected, inflation has already had real effects on American wallets. Hidden between the rows of numbers in the BLS report is a worrying revelation — that in a country already grappling with a meteoric rise in income inequality over the past 40 years, rising inflation is also hurting low-income Americans the most.

Income inequality has been at the forefront of economic worries in recent years, both among economists and the public. According to Pew Research data, of all the G7 countries, the United States has the highest measure of income inequality by far, with the top 10% of households earning 12.6 times the amount of the bottom 10% of households annually and high-income households now owning 79% of the total wealth. This yawning wealth gap has caught the eye of the public as well. 61% of Americans believe that there is too much income inequality, and 42% state that reducing income inequality should be a top priority of the federal government.

Inflation inequality compounds this problem, but unlike income inequality, there is far less data and research on this phenomenon and its effects. In general, inflation is often thought of as a monolithic number that affects all households in a standard way. This popular conception is likely compounded by the CPI’s one-size-fits-all approach to measuring the average change in prices paid by urban consumers. However, by reporting just a single statistic for each category of consumption, these numbers miss out on capturing the nuances of the varied levels and types of spending by Americans of different incomes.

First, lower-income Americans are necessarily forced to spend a higher proportion of their income on basic needs than their higher-income counterparts. The Brookings Institution has found that while high-income households spend about two-thirds of their budget on essentials, low-income households spend about 15% more, or 82% total. With so much more of their income spent on fewer categories of consumption, lower-income Americans are much more sensitive to rising prices for not only food and shelter, but most prominently gasoline, the demand for which is relatively price inelastic. Spending on basic needs as a proportion of the household budget has also continued to rise over the past 30 years, compounding the effects of inflation on the poor.

Furthermore, the prices of the specific goods and services consumed by low-income households are rising at a rate faster than that of the goods and services consumed by high-income households. In 80% of the months from 1983-2013, the Chicago Fed recorded a higher rate of inflation among the lowest quartile of income-earners compared to the top quartile, by about 0.23 percentage points overall. And while inflation in consumer goods is often offset by a degree of wage inflation as well, the trend of wage stagnation among lower-income Americans compared to their higher-income counterparts as income inequality has risen has further exacerbated the effect of price increases on the poor. As real wages flatline and inflation ramps up, the purchasing power of low-income Americans declines further and further.

Researchers at Columbia University’s Center on Policy & Social Policy have posited that this may also be fundamentally due to income inequality. According to Dr. Xavier Jaravel, one of the study’s authors, as the share of total wealth owned by upper-income families has soared, businesses have increasingly competedin the high-end market for upper-income consumers’ disposable income. This competition has driven down the cost of high-end goods and services that largely impact high-income consumers, without lowering the costs of lower-priced goods and services for low-income households proportionally.

We cannot end inflation, which is a natural component of the economy. But it is important for businesses and state actors to acknowledge and combat inflation inequality as a force that is just as threatening to low-income consumers as income inequality itself. Of course, as inflation inequality stems from inflation, it can be combated through the same mechanisms the Fed has traditionally taken to slow the rate of inflation, such as contracting money supply by raising interest rates and slowing its purchases of securities on the market. But if Jaravel’s theory is true, then a new solution to tamping down inflation inequality may be to combat the inequality part of the equation instead. Increasing rewards for companies doing business with low-income consumers would generate competition that increases product diversity and lowers prices for lower-end consumer goods over time. This would be a win for both businesses, who would be able to tap into a currently underutilized market, and poor Americans, who would benefit from increased offerings at more affordable prices. Though conventional wisdom may hold that there are lower profit margins to be found for businesses in the market for lower-price goods, companies like Pinoduoduo and Echale, among others, have been able to provide products and services at low cost that can reach low-income consumers in a way that is still profitable for the business.

To encourage these businesses, governments from the local to the federal level should provide subsidies or other benefits for their early-stage growth. Subsidies have been found to help companies serving low-income consumers mitigate the initial risks inherent in a market with low profit margins and high volatility, and importantly, have not been found to impede the eventual establishment of a financially self-sustaining business. Thus, providing local, state, and federal subsidies and tax incentives would represent not only an economic investment in the community but also a social investment for the good of all.