Inflation inequality between income groups reaches ‘historical highs’

New data reveals that the inflation gap between lower and higher-income groups has reached 'historical highs,' causing significant concerns for the economic well-being of low-income households. 

According to a policy note by the Central Bank of Malta, the inflation gap between the top 25% earners and the lowest 25% earners has exceeded the historical average, peaking at 1.2 percentage points in August, surpassing the previous gap of around 0.2 percentage points. 

Inflation is experienced differently between income groups due to their different spending habits. Low-income groups tend to spend a higher share of their income on essentials like food and housing, while higher-income groups spend a higher share, compared to lower-income counterparts, on luxuries like restaurants and hotels, recreation and culture, and transport. 

Since inflation rates include changes across different categories, the inflation rate experienced by lower-income groups might be higher due to, say, foodstuffs taking up a larger share of their income. As a result, inflation gaps persist between households depending on their income.  

The policy note states there is a notable discrepancy between the official inflation rate and the rate experienced by the lowest income groups, reaching 1.3 percentage points in August. These gaps mark the second-highest recorded disparities since 2013. 

The inflation gap is primarily driven by rising costs in essential areas like food and rent. The lower income and retired households are facing a higher inflation rate than their wealthier and younger counterparts. 

Food inflation, which holds a significant share in the consumption basket of the lowest income group, has played a pivotal role in skewing their inflation rate. Additionally, rent inflation surpassed food inflation as the primary driver of the gap since July 2023. 

Retired households experienced an inflation rate of 8.1% in December 2022. The inflation gap between the young and retired has also widened over the past two years, peaking at 1.5 percentage points in the winter of 2022 – the highest recorded gap since 2010. 

Notably, lower-income and retired households are facing a similar inflation rate. Without top-up benefits and the refined additional Cost of Living Adjustment (COLA) mechanism, pensions would have suffered a significant decline in purchasing power. Similarly, those on the minimum wage also lost part of their purchasing power over the past two years. 

In the policy note, researchers said the additional COLA mechanism should ensure that declines in purchasing power during inflation spikes are temporary, in the absence of second-round effects.  

All weekly pension rates, inclusive of bonuses, experienced some devaluation in 2022 due to the backward-looking nature of COLA and the lack of increments in statutory bonuses. However, considering all benefits, minimum pensions saw an increase in their real value in 2022, despite historically high inflation. On the other hand, maximum pensions experienced a slight deterioration in real value in 2022, even with additional top-ups over and above COLA. 

The CBM policy note was written by Aaron G. Grech, Ian Borg and Valentina Antonaroli.