What else would you expect from an analysis from Cologne, where 100.000 people of Turkish origin live? In an article in the monthly newsletter of the Institute for Economic Policy at the University of Cologne, Fabian Knapp examines the question of why the general inflation rate only partially reflects the real financial burden on individual households. As a typical example, the doner kebab, whose noticeable price increase is immediately noticeable to many people and therefore functions as a symbol of the rising cost of living, is used.
Official inflation is based on the price development of an average basket of goods and services. However, not all prices increase to the same extent. In particular, energy, food and other everyday goods can become significantly more expensive, while, for example, technical products or certain services can become cheaper. Therefore, the average inflation rate does not show how much prices have actually increased for a particular household.
Individual consumption behavior plays a decisive role. Households that spend a large part of their income on food, energy or rent are more affected by these price increases than households that have more financial room for other goods. People with low incomes are therefore particularly affected by sharp increases in the prices of essential goods, as they have less flexibility to adjust their consumption behavior.
Empirical studies from the US confirm these differences. Kaplan and Schulhofer-Wohl of the Gerzensee Study Center of the Swiss National Bank show that individual household inflation rates differ significantly from one another. Part of these differences are due not only to different consumer baskets, but also to the fact that households pay different prices for comparable products. For example, the place of purchase, the quality of the product or discounts can play an important role. Furthermore, between 2004 and 2013, cumulative inflation for low-income households in the US increased more than for affluent households. Argente and Lee, of the Universities of Pennsylvania and San Diego in California respectively, also show that wealthier households can, in times of crisis, more easily switch to cheaper products, other stores or discounts. For the poorest households, these possibilities are clearly more limited.
These findings also have implications for monetary policy. Central banks have traditionally been oriented towards general consumer price inflation (CPI). The article, however, presents a model by Olivi, Sterk and Xhani (University College London, Norwegian School of Economics and Center for Economic Policy Research in Paris respectively), which takes into account the different consumption baskets of households. Accordingly, a “Marginal Consumer Price Index” (MCPI) could be more appropriate for monetary policy decisions. This index gives greater weight to goods on which households spend additional income and, therefore, weighs luxury goods more heavily than necessities.
In the case of a supply shock that, for example, only increases the prices of necessities, dealing harshly with the resulting rise in CPI inflation through large interest rate increases would unnecessarily weigh on economic growth. The optimal monetary policy in such a case would therefore have to accept a certain degree of inflation increase in order to avoid a recession.
Phaedon G. Kotsambopoulos, physician, President of the German-Hellenic Business Association DHW, Cologne/Germany
photo mariya_m, https://pixabay.com
