Pablo Hernández de Cos: Inflation and household income distribution

Speech by Mr Pablo Hernández de Cos, Governor of the Bank of Spain, at the Annual Congress of the European Economic Association (EEA), Barcelona, 30 August 2023.

Central bank speech  | 
01 September 2023

I would like to thank the European Economic Association (EEA) for inviting me to take part in this event.

After a decade of inflation being persistently low, its surge since mid-2021 and its persistence has brought back the debate on the economic consequences of a significant increase in inflation. In my address today, I would like to focus on how inflation affects and redistributes wealth across households. People are afraid of inflation because it makes them "poorer"; however, as we will see, its effect is not homogeneous.

I will start by describing the three main channels through which an unexpected increase in inflation can affect an individual's wealth.

First, inflation redistributes real wealth from lenders to borrowers by changing the real value of nominal assets and liabilities. This is commonly known as the wealth or Fisher channel. 1 By real wealth I mean nominal wealth (e.g. in euros or dollars) expressed in units of a basket of consumer goods and services; in other words, nominal wealth rescaled by the level of consumer prices. The impact of inflation on real wealth is fully captured by the net nominal position, defined as the difference between nominal assets and nominal liabilities. While inflation will reduce the real value of both of these, the net effect on a given household's real wealth will depend on the relative size of such assets and liabilities in that household's balance sheet.

Second, nominal income sources, such as wages, move slowly in most advanced economies. They are "sticky". Therefore, during an initial phase, unexpected high inflation episodes tend to reduce the real value of nominal income, and consequently of real wealth. However, after the unexpected shock, wages and other sources of income may evolve differently across workers, while in many countries some sources of income, such as pensions, are indexed to inflation. Thus, inflation could have an uneven impact on the real income of individuals. Let me call this the "income channel".