Income inequality in times of high inflation in Europe

• Measuring economic wellbeing in terms of nominal incomes prevents from adequately taking account of the effects of inflation on the distribution of living standards. • We consider income net of the spending for basic goods as the proxy of economic wellbeing to account for the impact of inflation on inequality. • We carry out an empirical exercise for 5 major EU countries referring to 2020–2023 inflation occurred in 2020–2023, based on EU-SILC 2020 which records household spending for food. • We find that inequality largely increases when incomes are considered net of the spending for food and when such spending is inflated. • Inequality also rises if all incomes increase according to the average inflation rate, because of the higher relative spending of poorer households on a good, such as food, characterised by a higher than average inflation rate. In inequality studies economic wellbeing is usually measured in terms of nominal incomes, which are compared over time by using a uniform price index. This prevents from adequately taking account of the effects of inflation on the distribution of living standards. To overcome these limits, we propose to consider income net of the spending for basic goods as the proxy of economic wellbeing. Such approach allows to account for the impact on inequality of the heterogeneity in the share of income spent for these goods and in the inflation rates across goods. We test this approach through an empirical exercise for 5 major EU countries, based on the 2020 wave of the EU-SILC which records household spending for food. Referring to inflation rates occurred in 2020–2023, we investigate: i) the changes of inequality when income net of food spending is considered as the proxy of economic wellbeing; ii) the ‘direct’ change of inequality when food price increases; iii) the capacity of a ‘uniform’ rise in incomes to counteract the effects of an increase in food price. We find that inequality largely increases when incomes are considered net of the spending for food and when such spending is inflated and this effect is driven by the declining ratio between food spending and household income along the income distribution. Inequality also rises if all incomes increase according to the average inflation rate, because of the higher relative spending of poorer households on a good, such as food, characterised by a higher-than-average inflation rate.