Notes On The Front

Confronting a Higher Inflation Future

With inflation projected to climb to 4.5 percent next year, and continuing at levels in excess of pre-pandemic trends, it is time to assess the varying impacts on income groups.  Inflation affects households in different ways, depending on income and consumption patterns.  But generally low-income households will fare the worst.   Let’s see if we can estimate it.

Across the Board

The following stylised estimate comes with explanations.  First, this is not an attempt to measure inflation by income group, but rather the impact of higher prices on income levels.  Second, income and expenditure data comes from the 2016 Household Budget Survey so this data is a little out of date.  Third, this takes the 5.5 percent headline inflation rate (12 months to December) and applies it to total expenditure regardless of the composition of that spending.  Finally, the additional expenditure arising from inflation is measured against total disposable income.

This is what we find.

For the lowest-income group, inflation over the last year represents 8.5 percent of their income.  At the highest end, it represents 4.2 percent of income – or less than half the impact on the lowest income group.

This should be treated indicatively.  However, this regressive trend shouldn’t surprise us.  It is a function of higher savings at the upper levels.  For instance, a household whose expenditure is equal to revenue (i.e. they don’t save) will face the full impact of inflation as a percentage of income.  However, households that save will experience inflation as a smaller proportion of income.  For instance:

• In the highest income group, households spend 76 percent of their income

• In the 9^th decile, households spend 89 percent of their income

This doesn’t factor in income rises over the year.  And as income and spending data dates from 2016, there could be a change in the gap between highest and lowest income groups.  The CSO’s Survey on Income and Living Conditions shows that the ratio between the highest and lowest income fell.  But we should also be mindful that, were all households impacted equally, living standards for low-income households would end up worse as they would have to reduce their spending (e.g. turn off the heat in the house, consume less food) or go into debt.  Higher income households just save slightly less.

Factoring in Energy Inflation

Let’s wade a little further into the data pond and factor in the impact of domestic energy prices.  While inflation averaged 5.5 percent, energy prices (gas, electricity, other fuels) experienced a 27 percent rise.  All other goods and services rose by 3.6 percent.

If lower income groups disproportionately spend more (as a percentage of their income) on energy, then the regressive trends we saw above could be exacerbated.  And that’s exactly what happens when we factor in energy prices.

Inflation is even higher in the lowest income group, while at the highest level the impact of inflation on revenue falls.  Why does this happen?  In the lowest decile, spending on energy makes up over 9 percent of total expenditure; at the highest end this figure is 3 percent.   Therefore, we shouldn’t be surprised that inflation rises even higher for low-income groups given the level of spending on light and fuel.

However, there is a major health warning in starting a decomposition of average inflation rates.  For instance, lower income groups spend a higher proportion on food.  Food inflation over the last year has been well below the average (1.2 percent compared to an average 5.5 percent).  So if we were to factor in food inflation, we would probably see the gap between the lowest and highest income groups narrow.

[NOTE:  while over the year food inflation has been below average, in December it exceeded the average on a month-to-month basis.  If food inflation continues to trend above the average, it could be even more damaging to low-income living standards.]

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Where does all this leave us? 

• First, the above is just a crude approximation.  It would be extremely helpful if the CSO disaggregated inflation by deciles and other categories (age, housing tenure, etc.) so that we could get a more informed perspective on the impact of inflation.  The ESRI could also assist using their SWITCH model.  It was only after researching this blog post that I came across this Twitter thread from Pearse Doherty, TD, who has written to the CSO seeking such an inflation breakdown. 
• Second, we will need to rethink how we redistribute income, moving away from the annual ‘here’s a fiver’ approach to social protection payments.  Even linking such payments to average inflation doesn’t take into account of the fact that inflation could be above-average for households reliant on social protection.
• Third, among households that are in formal employment, we are likely to see that inflation is higher for the low-paid.  This calls for wage and income strategies that benefit the lower-paid.
• Fourth, we need to address the structural factors in prices; otherwise we’re in danger of cash subsidies chasing prices.  Treating energy as a ‘public good’ with price regulation could help smooth out energy price cycles.  Targeting free, upfront retrofits – especially for older households and old buildings – can reduce energy consumption and, so, costs.  Reducing the costs of public services would also help drive down costs (e.g. public transport fares, as would tackling housing costs (e.g. rent freeze).

Through a range of redistribution and regulatory measures we can start to meet the challenge of a higher inflation environment. 

A good start is to get a robust analysis of inflation and living costs throughout all the different sectors of society.

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NOTE:  All inflation and Household Budget data taken from CSO. I find it difficult to link individual tables within the CSO's databank.  Any suggestions would be welcome.

Anything We Can Actually Do, We Can Afford

Let’s begin 2022 on a positive, even outrageously optimistic, note. 

Yes, there’s inflation, pandemic disrepair, geo-political instability, low wages, precarious work, social deficits and increasing demands on under-funded public services.  But there will be time to depress ourselves over these.  Let’s start with a hopeful analysis.  And who better to go to than John Maynard Keynes, who said,

‘Anything we can actually do, we can afford’.

All the dire predictions of the fiscal pessimists are swept aside like so many budget begrudgeries.  Finance is an instrument, not a master.   Policy is determined by our own capacities, not by our pockets. 

‘Anything we can actually do, we can afford’ is the watchword(s) of the new political economy.

Keynes made this statement in a 1942 lecture on BBC radio.  Here is the context.

‘Let us not submit to the vile doctrine of the nineteenth century that every enterprise must justify itself in pounds, shillings and pence of cash income … Why should we not add in every substantial city the dignity of an ancient university or a European capital … an ample theater, a concert hall, a dance hall, a gallery, cafes, and so forth. Assuredly we can afford this and so much more. Anything we can actually do, we can afford . . . Yet these must be only the trimmings on the more solid, urgent and necessary outgoings on housing the people, on reconstructing industry and transport and on replanning the environment of our daily life. Not only shall we come to possess these excellent things. With a big programme carried out at a regulated pace we can hope to keep employment good for many years to come. We shall, in fact, have built our New Jerusalem . . .’

Keynes’ dictum has gained new currency during the pandemic.  Who would have thought in 2019 that we would be able to spend billions on subsidising people in work and out of work? Who would have thought that billions spent on business subsidies would not only be possible but desirable?  Who would have predicted essentially free health services and the takeover of private hospitals? 

Had you predicted  any of this in 2019 you would have been laughed out of the media studios.

‘How could we afford this?’ would have been the refrain.  And, yet, we did.

Of course, there are caveats and conditions.  Inflation is a key constraint. Keynes wrote:

‘The . . . task is to prevent a demand in excess of the physical possibilities of supply, which is the proper meaning of inflation. For the physical possibilities of supply are very far from unlimited . . . Having prepared our blue-prints, covering the whole field of our requirements and not building alone—and these can be as ambitious and glorious as the minds of our engineers and architects and social planners can conceive—those in charge must then concentrate on the vital task of central management, the pace at which the programme is put into operation, neither so slow as to cause unemployment nor so rapid as to cause inflation.‘

This has lessons for our housing programme.  The first issue is not the money but the capacity.  Do we have the labour, the supply chains, efficient public procurement rules, the land?  How does this balance with other demands for retro-fitting and other building and infrastructural projects?  And at what point does the programme start ‘over-heating’, with investment chasing prices rather than completing housing?  This should lead us to emphasise quality and long-term sustainability over setting tenuous targets.

This is about changing the debate from ‘can we afford it’ (yes, we can) to ‘can we actually do it’?  Most days I walk past St. Mary’s Mansions, a social housing estate in Dublin’s North Inner City.  It underwent a massive regeneration which resulted in the highest energy rating, new communal spaces (play areas, etc.) and new units, housing more – all for the price of €23 million; essentially pennies behind the sofa which will be recouped in the years ahead.  This could serve not only as a template for social housing, but all housing.  Dr. Rory Hearne highlights the challenges and benefits of bringing the vast number of empty and derelict housing units back into use.

The real driver of doing and affording, however, is somewhat out of our control.   The EU Commission is currently reviewing the Fiscal Rules.  A return to the old normal or a withdrawal of the ECB backstop to sovereign debt would undermine attempts to finance what is necessary.  That’s why it is imperative the Irish government support the arguments that investment – especially green investment – be exempt from deficit and debt calculations; that productive investment be central bank-financed.   It is imperative that opposition parties hold the government to account on this. Sensible fiscal rules and central bank support for investment would help ensure that what we can do, we can afford.

Even without this, the Irish government can still increase resources under the current rules (always remembering inflationary pressures), investing billions more by 2025 than what is currently projected.  Keeping growth ahead of borrowing still reduces debt, but more importantly can reduce economic inefficiency and social need. The only limitation is capacity.

This requires a different dialogue.  It requires – again, relying on Keynes – a managed 'quasi-boom', a macro-economic policy that the current Government would find difficult given their ideological blinkers (and given the main coalition parties’ track record, I’m not sure I’d like to see them try).  To meet the challenges – from post-pandemic repair, to climate chaos, automation and a low-growth future – we will need to do things differently. 

And the good news is that what we can actually do, we can afford.