Monday, September 20, 2010

Much Of Income Inequality Disappears With Adjustments For Different Inflation Rates For Upper And Lower Income Groups

A research paper, "The Welfare Implications of Rising Price Dispersion" by Christian Broda, University of Chicago, GSB and John Romalis, University of Chicago, GSB, finds that US income inequality measures are distorted by different inflation rates for upper and lower income groups. Upper income groups face higher inflation rates and therefore when accurate adjustments are made to real dollars, a substantial part, if not all, of income inequality between the upper and lower income groups disappears.
From the Broda and Romalis' paper:
Using scanner data on household consumption of non-durable goods between 1994 and 2005, we document that the relative prices of low-quality products that are consumed disproportionately by low-income households were falling over this period. This implies that non-durable inflation for the 10th percentile of the income distribution has only been 4.3 percent between 1994 and 2005 (0.4 percent per annum), while the non-durable inflation for the 90th percentile has been 11.9 percent (1.0 percent annually), and 13.4 percent (1.2 percent annually) for the richest 5 percent of households in the sample. Over the period 1994 – 2005, the conventionally measured ratio between real household income at the 90th and 10th percentile rose by 5.7 percent (0.5 percent per annum) and the 95th/10th ratio rose by 7.5 percent (0.7 percent per annum). This suggests that the inflation differential in non-durable goods (around 30 percent of total consumption) is enough to offset almost 40 percent of the rise in both of these inequality ratios over this period. In the case of other common inequality measures, the 80/20th and 95/20th income ratios, the non-durable inflation differential is enough to offset over 80 percent and 50 percent, respectively, of the rise in these indicators. Moreover, we provide evidence that suggests that the increase in price dispersion is not limited to the products in our sample nor to our time period. If differences in income-group specific inflation rates in our sample are representative of the broader economy, then real income growth in the US has been much more substantial and equal than suggested by standard measures. In that case, “real” inequality may have actually fallen between 1994 and 2005.
Read the entire research paper here.

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