With inflation, many lose a lot (and some win)

The National Institute of Statistics of Spain (INE) has just published the advance indicator of the CPI for March: 9.8%. If the data is confirmed, it would be the highest year-on-year inflation rate since 1985!

This figure shows that the Storm clouds of the inflation that we announced in October 2021 jarrean strongly on the Spanish economy.

It is true that the risks that explained the inflationary tensions at that time are not the same as today. But the consequences are: the important redistributive effects produced by inflation. And the result of them, the increase in social conflict.

Inflation is not a zero-sum game but rather a loss for almost everyone, since it causes the impoverishment of the economy as a whole. Especially when it is produced by a shock as acute as the escalation in energy prices (gas, oil). Some goods that, in addition, are imported. First loss: there is a transfer of income from importing and highly dependent economies (Spain, for example) to exporting countries (Russia, mainly).

Inflation, aid and subsidies

With high inflation one of the winners is the State. Its collection increases through special taxes (on fuel, for example) and also through direct taxation, if the tax brackets are not updated according to the rise in prices.

Internally, inflation undermines the purchasing power and this generates a struggle of the different economic sectors to maintain their purchasing power which, in this episode of generalized inflation, is having a response through various government measures:

  1. The decoupling of electricity prices in the wholesale market from international gas prices.

  2. The fuel subsidy for electro-intensive industries (here comes road transport and other groups with less economic weight that have also joined the demands, such as driving schools).

  3. The general fuel subsidy. This, in the form of lower taxes or the establishment of rebates for consumers.

None of this eliminates the problem: the increase in the price of an imported good whose consumption should be sharply reduced. Rather, it distributes the cost of the adjustment among all.

In the first case, the decoupling harms the electricity companies and their shareholders. Until now, the way of setting prices in the electricity market has made the electricity companies the big winners of the rise in gas, since they have been able to transfer the increase in their costs to the market and, in addition, obtain extraordinary profits (heaven-sent profits) thanks to the marginal market system.

In the case of subsidies, premiums and tax cuts, all these measures entail an increase in public spending that the economies (some, like the Spanish, already highly indebted) must assume, with which the payers of the increased debt will be the next generations.

But the State is under pressure not only from the different economic sectors, but also from civil servants and pensioners, who demand rises to protect themselves from inflation. And that generates more public spending.

Subsidies and containment of energy consumption

East shock It has to be approached from a very different perspective than usual. Due to the exceptional nature of war, it is important to establish a strategy that reduces energy consumption quickly and significantly.

If, as a result of the measures to support the economic sectors and the population in general, the demand for energy does not fall, in addition to the fact that the basic problem will not be solved, it will be pouring gasoline on the fire. Subsidy systems have a limit, which is much narrower in indebted economies.

When the EU’s Vice President for External Action, Josep Borrell, alluded to the opportunity to lower the heating a few degrees, many took it as a joke.

The point is that these small individual gestures have very significant impacts on the global energy bill. Reducing mobility would also be a measure to be evaluated and implemented: there is already experience with teleworking in a pandemic but it could be extended to other areas.

Altering prices with aid or subsidies does not contribute to making decisions that, although they imply a certain loss of well-being, reduce energy dependence, an issue that has been revealed to be key as a result of the war launched by Putin against Ukraine.

Spending instruments (such as subsidies or tax cuts) must be used very selectively. They are extraordinarily expensive instruments for national accounts and generate distorting effects on the allocation of resources. Therefore, they should focus on the most vulnerable groups, which experience the costs of inflation to a greater extent.

Energy, shopping basket and inflation

Inflation undermines purchasing power but not all income equally. Although its evolution is calculated on an average consumption basket, not all households consume the same. There are very significant differences by income level and by type of household.

The INE Family Budget Survey offers interesting results when household consumption patterns are analyzed by income quintiles (from the lowest 20% income to the highest 20% income).

Average spending per household, percentage distribution, annual variation and absolute difference by spending groups. Year 2020.
Source: INE, Family Budget Survey (EPF).

According to the latest HBS published (2020), the poorest households spend 22.1% of their income on food compared to 12.8% of the richest households. As for the Housing line (which includes the consumption of water, electricity, gas, etc.), the poorest households spend 44% compared to 31.7% in the rich. These are the two spending groups that mostly explain the price increases in the CPI.

It is laborious (but feasible) to calculate price indices distinguishing between different categories, as the US statistical office does. It is very useful that inflation data is published by income levels, or differentiating between urban and rural households , or due to their different configuration (older people living alone, young couples without children…).

Inflation and taxes

In periods of inflation, while the purchasing power of citizens decreases if their income does not match the rise in prices, the State maintains its collection. This is how the call is generated inflation taxbecause the higher the inflation, the greater the difference between the real value and the nominal value of money.

In a recent study by the RegioLab research group (University of Oviedo), the impact of the rise in fuel prices on a sectoral and regional scale has been analysed. The document offers interesting conclusions from which we extract just one piece of information: households made up of a single person, who is over sixty-five years of age (statistically, it can be a widow living alone) experience a price increase almost 25% higher than average.

This result shows that inflation does not cost us all the same. It’s a tax which especially affects the poorest and most vulnerable households.

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