Two years after an inflation shock, a sharper decline in the purchasing power of better-off households

An increase in the general price level, for whatever reason, has lagged effects on the disposable income of households. These effects go through three channels: First of all, wages react, with the annual adjustment of the minimum wage, and wage negotiations to preserve purchasing power. Secondly, welfare and tax rates, as well as some income substitution benefits, are reset according to legal or standard inflation indexing criteria. The third channel stems from the time lags imposed by French legislation, since income tax is paid one year in arrears (year N+1), and some benefits received in year N+2 are based on income earned in year N.

The two-year impact of an inflation shock on household purchasing power is analysed using the Ines microsimulation model, based on data representative of the population in metropolitan France in 2015.

Two years after an additional 1-point rise in inflation, real disposable household income (deflated by prices) is on average 0.3% lower than it would have been had there been no increase, under certain assumptions about the indexation of income and price dynamics. The drop in purchasing power can be explained primarily by the real-term decline in income before redistribution, which accounts for -0.5 points. Taxes and social security contributions mitigate the decline slightly, accounting for +0.1 points of the variation in real disposable income. Benefits have no impact at all.

The loss of purchasing power increases in line with the standard of living: It stands at -0.1% for the lowest-earning 10% of households, compared with -0.6% for the highest-earning 10%. There are two cumulative effects. First of all, the higher the income, the less it is indexed to prices. Added to that is a composition effect: The share of inflation-linked social transfers in disposable income falls in line with the income level, whereas the share of earnings and investment income — which change little according to prices — grows. Overall, living standard inequality is very slightly lower than when inflation remains stable (-0.001 for the Gini index and -0.4% for the decile ratio).