Inequality, cost of living, and business cycles
Jacob Orchard examines the cyclical behavior of low-income versus high-income household price indices in this paper. He creates 119 product sectors in the Consumer Expenditure Survey (CEX) that represent the same type of spending from 1991 to 2019. Then he sorts households into five different income quintiles and constructs a measure of the relative importance of a product in a low-income household’s consumption basket. Using price data for a subset of products from 1967-2020, he can observe the cyclical behavior of necessity and luxury goods prices over seven different recessionary periods. He shows that 24 months after a 25 basis point contractionary monetary policy shock, aggregate expenditure falls by approximately 2 percent but the aggregate share of spending devoted to necessity products increases by 5 percent, and relative necessity prices increase by around 2.5 percent.
Finally, Orchard uses a quantitative New Keynesian model that incorporates non-homothetic preferences and can be calibrated to the US economy. He finds:
[T]he difference in cost-of-living between low and high-income households varies systematically over the business cycle: increasing during recessions and subsiding during expansions. This cost-of-living channel is yet another reason why recessions are particularly costly for low-income households.
Cyclical Demand Shifts and Cost of Living Inequality
Author: Jacob Orchard
From: University of California, San Diego
