Inflation's winners and losers

Who has fared the worst from the recent bout of inflation and ongoing cost of living crisis? It’s not who you might think from reading headline after headline about Australia’s rental crisis:

“On average, households with a mortgage have experienced a significant decline in spare cash flows, unlike other households. For these households, higher interest costs have reduced their cash flow by more than the rise in inflation has. By contrast, the spare cash flow of renters has, on average, risen a little as high inflation and rising rents have been more than offset by growth in income. There will, of course, be diverse outcomes for individuals within these groups.”

That’s from the Reserve Bank of Australia (RBA), which offered up the following chart in support:

It’s a curious feature of the post-pandemic inflation that the losers haven’t been who you might have suspected at the outside (i.e., lower income workers/renters). A recent study from the US found that because of an increase in labour market competition, wages in the bottom of the distribution have been improving so much that they have “counteracted approximately one-quarter of the four-decade increase in aggregate 90-10 log wage inequality”. According to the authors:

“Seen through the lens of a canonical job ladder model, the pandemic increased the elasticity of labor supply to firms in the low-wage labor market, reducing employer market power and spurring rapid relative wage growth among young non-college workers who disproportionately moved from lower-paying to higher-paying and potentially more-productive jobs.”

Most of the gains were accrued by workers switching jobs rather than getting a pay rise or promotion. I wondered whether the same would be true in Australia and then Seek was kind enough to put out this chart, which would suggest that it probably is:

If you’re designing policy to support people in a cost of living crisis, these are important facts to know. For example, targeting all renters would be a huge mistake: on average they’re actually better off than they were before the pandemic, at least in terms of spare cash flows. Doing so would also risk funnelling cash into the pockets of well-to-do renters who prefer that lifestyle or are, say, building a new house and only renting temporarily – perhaps incentivised as part of the federal government’s last overzealous support scheme, HomeBuilder.

Other popular ideas to help renters as a group, such as freezing rents, would be just as disastrous, as it would come with huge unintended consequences for the housing sector as a whole (as fixing prices always does) for very debatable welfare gains.

If the government wants to help renters who are struggling – as the RBA is careful to note, “Within each group, there will be individual households that are better off and some that are worse off than average” – it needs to carefully target those who actually need the help. If it instead tries to hit the entire cohort with a broad brush of welfare, it risks spending a huge amount of money that could have been much better utilised elsewhere (like helping those who are actually worse off, regardless of their living arrangements).