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Is There Ination Inequality Across Household Types in Europe?

Roberta Colavecchio & Ulrich Fritsche & Michael Graff

Hamburg University & KOF ETH Zurich

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Outline
Introduction Ination Inequality across Households: why should we care? Literature Review Our Approach Research Questions Data Set Empirical Analysis Stationarity Convergence Issues Pooled Analysis- preliminary Conclusion Country-by-country analysis Panel analysis To do list
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Introduction

Ination as a macroeconomic phenomenon (general rise in the overall price level) Typically ination is measured on the national level, using a representative household concept (HICP - baskets harmonized throughout Europe) Extensive literature on price level/ ination rate and business cycle convergence/ divergence across nation states in Europe (EU/ EMU) However, the literature on the distribution/ structure of ination rates within countries (or within Europe) faced by households across different socio-economic categories is rather limited

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Introduction

In this paper, we analyse cross-household ination dispersion in Europe using ctitious monthly ination rates for several types of households (grouped according to income levels, household size, socio-economic status, age) The data set covers the period from 1997 to 2008 (update: 2010) Panel of 23 (up to 27) household-specic ination rates per country 15 European countries and the euro area aggregate

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Introduction

The paper consists of two parts:


1. In the rst one, we employ time series and non-stationary panel techniques to shed light on cross-country differences in ination inequality with respect to the number of driving forces in the panel (Focus: the degree of persistence of the household-specic ination rates and their adjustment behaviour towards the ination rate of a representative household); 2. In the second one, we pool the full sample of all countries and test if and by how much certain household categories across Europe are more prone to signicant ination differentials and signicant differences in the volatility of ination.

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Introduction
Ination Inequality across Households: why should we care?

1. Poverty reduction and income redistribution measures are mostly aimed at stabilizing real income at low income levels knowing the features of the ination rates faced by those household categories might improve the effectiveness of the measures 2. Elderly people (whose relative importance is constantly increasing in our ageing society) often show a quite different consumption pattern compared to the median household. 3. Savings rates differ across, e.g., age and income groups; ination rates might differ as well. As households are concerned about their real consumption and savings possibilities, differing ination rates give raise to a possible amplication of wealth effects in the economy as a whole

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The KOF/ UHH-Report for the EU Commission, DG ECFIN (2009)


Ination Dispersion

Figure: Differences with respect to HICP in EU-15

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The KOF/ UHH-Report for the EU Commission, DG ECFIN (2009)


Weight Dispersion (1999)

Figure: Differences in weights in EU-15

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Introduction
Literature Review

United States
Michael (1979), Hagemann (1982): after the rst and second oil price shock, low income households, households with lower education, older-aged households face higher than average ination. However, within group differences are typically more pronounced than differences between groups; Amble and Stewart (1994): found higher ination for the elderly due to above-average increases in medical costs in the US; Hobijn and Lagakos (2005): elderly are more prone to ination, poorer households as well. Differences to median ination are, however, not very persistent; Idson and Miller (1997): ination in the US is falling with the level of education (due to fuel, energy)

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Introduction
Literature Review

Canada
Chiru (2005): higher ination for elderly and low income households

Europe
Livada (1990) for Greece: Childless couples and high-income households face highest ination; Crawford and Smith (2002) for the UK: persistent differences in ation rates (opposite to the ndings of Hobijn and Lagakos, 2005): non-pensioners, mortgage-payers, childless households are more prone to ination; Noll and Weick (2006) for Germany: conrm Engels law, signicant but small differences in ination and consumption patterns; Rippin (2006) for Germany in the 1998-2003 period: lowest ination among the youth (telecommunication)

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Our Approach
Research Questions

Questions:
1. Do household-specic ination rates deviate from the ination rate faced by the representative household? 2. Are these deviations persistent? If not, how long do these deviations last? How large are they? Are they signicant? 3. Does the volatility of household-specic ination rates differ across categories compared to the representative household ination? 4. Can we identify clusters of households which feature (statistically) similar rates of ination?

We construct a data set of cticious household-specic monthly ination rates

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Our Approach
Data Set

Source: Eurostat (Household Budget Surveys and HICPs) Countries:


1. EMU, i.e. 12 countries 2. Plus Sweden, UK, Denmark and the euro area aggregate

Time span: January 1997 December 2008 Categories of prices: COICOP 1-12 What socio-economic categories can we refer to?
By employment status (manual, non-manual, self-employed, unemployed, ...) By number of active persons By income quintile By household type (single, single with dependent children, two adults, ...) By age

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Our Approach
Data Set

HICP has annually changing weights (chain index), the HBSs are conducted every 5 years (data frequency mismatch!) We selected a base year (where we have both types of data), calculate the distance of the weights and keep the relative distance constant Reference ination rate slightly differs from HICP, we use the average over all households in the Consumer survey (consistency issues)

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Our Approach
Data Set

Table: Description of COICOP Categories


Category cp1 cp2 cp3 cp4 cp5 cp6 cp7 cp8 cp9 cp10 cp11 cp12 Description Food, and non-alcoholic beverages Alcoholic beverages and tobacco Clothing and footwear Housing, water, electricity, gas and other fuels Furnishings, household equipment and maintenance of house Health Transport Communication Recreation and culture Education Hotels, cafes and restaurants Miscellaneous goods and services

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Our Approach
Data Set

Figure: Weights for the 12 COICOP categories in HICP (1996-2008) in Euro area
1,000

800

600

400

200

0 96 97 98 99 00 01 02 03 04 05 06

EA_CP1 EA_CP4 EA_CP7 EA_CP10

EA_CP2 EA_CP5 EA_CP8 EA_CP11

EA_CP3 EA_CP6 EA_CP9 EA_CP12


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Our Approach
Data Set

Figure: Household specic ination rates, pooled data, 1997m01 to 2008m11 (n = 52,910)

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Our Approach
Data Set

Figure: Deviations of household specic ination rates from country means, pooled data, 1997m01 to 2008m11 (n = 52,910)

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Empirical Analysis
Time series and non-stationary panel techniques are employed to explore cross-country differences in the persistence of household-specic ination rates and in their adjustment behaviour towards the representative household ination. In particular, we assess: Stationarity of ination rates (panel unit root tests) Convergence issues:
PANIC1 approach (Bai and Ng, 2001, 2004); Panel cointegration tests (on a country level); Bivariate error correction models (special focus on adjustment speed)

Panel Analysis of Nonstationarity in the Idiosyncratic and Common components.


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Empirical Analysis
Stationarity

Question: From a country-specic perspective, are the household-specic ination rates stationary or not, i.e. do household-specic ination rates show some persistence? Panel unit root tests, 2 assumptions:
1. common unit root process, i.e. the persistence parameters are common across cross-sections (household categories) (Levin et al. (2002)); 2. individual unit root, i.e. the persistence parameters are allowed to vary freely across cross-sections (Maddala and Wu (1999) and Choi (2001))

For the majority of the countries of our panel (and irrespective of the deterministic assumptions):
1. the tests fail to reject the hypothesis of a common unit root process; 2. the hypothesis of an individual unit root process is rejected
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Empirical Analysis
Stationarity

On the basis of the outcome of this rst set of tests, we could conclude that: Persistence over time is expected in our dataset The persistent component in each countrys household-specic ination rates is likely to be driven by a single common source

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Empirical Analysis
Convergence Issues - PANIC approach

Question: Are the different household-specic ination rates driven by one or more common trends? PANIC approach (Bai and Ng, 2001, 2004)
Idea: Decompose the model in the driving common factor(s) (Ft ) and the idiosyncratic components (eit ) Xit = ci + i Ft + eit where:
Xit are the household ination rates; The common factor is interpretable as the ination rate shared by all types of households (not necessarily HICP); The idiosyncratic components are measures of household-specic parts in their respective ination rates

(1)

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Empirical Analysis
Convergence Issues - PANIC approach

PANIC approach (Bai and Ng, 2001, 2004) Step 1: Determine the number of common factors according to information criteria Step 2: Test for stationarity of the common factor and idiosyncratic components (is the common factor the only source of non-stationarity in the panel of household-specic ination rates?)

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Empirical Analysis
Convergence Issues - PANIC approach

Table: Determining the number of factors (PANIC approach)


Variance proportion of it explained by... First principal component Second principal component 0.990 0.006 0.991 0.007 0.987 0.006 0.983 0.011 0.994 0.005 0.987 0.009 0.978 0.018 0.993 0.004 0.984 0.010 0.981 0.016 0.987 0.010 0.996 0.003 0.983 0.013 0.976 0.017 0.982 0.014 0.976 0.017

Austria Belgium Germany Denmark Euro area Spain Finland France Greece Ireland Italy Luxembourg Netherlands Portugal Sweden United Kingdom

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Empirical Analysis
Convergence Issues - PANIC approach

Results:
Step 1: One main common factor the panel of household-specic ination rates in each country seems to be driven by one single factor; Step 2: The hypothesis of a unit root in the common factor can be rejected for several countries (Germany, Denmark, Euro area, Spain, Italy, Luxembourg, Portugal and Sweden) there is a signicant proportion of non-stationarity remaining in the idiosyncratic components (implying persistent deviations of the idiosyncratic parts from the common component); The remaining part of the cross-sectional variance in the panel is driven by stationary idiosyncratic components (UK excluded), i.e. the part not explained by the single common factor in each country is mean-reverting with a constant variance Good news: individual household ination rates do not diverge permanently without bounds from the common factor
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Empirical Analysis
Convergence Issues - Panel co-integration tests

Question: Do household-specic ination rates feature mean-reversion towards the representative household ination? If not lasting or permanent gap between the ination rates experienced by the representative consumer and the ones faced by specic household categories. Panel co-integration tests (country-panel analysis: are the household-specic ination rates cointegrated with the respective representative household ination?)
Kao (1999) test: strongly rejects the null of no cointegration in all the country panels (i.e. suggests the presence of at least one cointegrating relationship); Maddala and Wu (1999) test: validates that a single cointegrating vector exists in the ination rate panel of all the considered countries (except Luxembourg)
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Empirical Analysis
Convergence Issues - bivariate ECMs

Question: do household-specic ination rates adjust towards the ination rate faced by the representative household? Individual adjustment behaviour (bivariate ECMs)
nx ny

yt = a0 y (yt 1 bxt 1 ) +
j =0 kx

axj xt j +
j =1 ky

ayj yt j + uyt

xt = b0 x (yt 1 bxt 1 ) +
j =1

bxj xt j +
j =0

byj yt j + uxt

where:
yt indicates the household-specic ination series xt indicates the representative household ination series

The speed and the direction of the adjustment process between yt and xt are mirrored in the behaviour of y and x (ECM loading coefcients)
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Empirical Analysis
Convergence Issues - bivariate ECMs

Results:
Different convergence assumptions (i.e. absolute or relative convergence) deliver different pictures of the behaviour of the loading coefcients. Under the assumption of absolute convergence, only the ination rates of households
featuring unemployed and inactive members with no active person formed by a single component formed single parents with dependent children

adjust towards the representative household ination (signicant y )

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Empirical Analysis
Convergence Issues - loading coefcients

Under the assumption of relative convergence,


The number of signicant loading coefcients under relative convergence increases; Households with one active person display, on average, the largest loading coefcient together with households belonging to the fourth quartile of the income distribution; For the majority of the socio-economic categories the adjustment speed towards equilibrium is low the household-specic ination rates deviate persistently from the representative household ination

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Empirical Analysis
Systematic patterns - pooled analysis

In differences: Ination for households at the lower end seems to be 0.05 percentage points lower, ination for households at the higher end seems to be 0.09 percentage points higher than the average

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Empirical Analysis
Cluster analysis

Euro area/ EU 15 data Hierarchical Ward algorithm, applied to the squared Euclidian distance Algorithm focuses on the within-group homogeneity rather than on the dissimilarity between clusters, and hence is appropriate to explore whether there are clusters of households sharing common household-specic ination rates

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Empirical Analysis
Cluster analysis

Figure: Cluster algorithm result

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Empirical Analysis
Cluster analysis

Table: Cluster membership


Variable socWork socFree actPers2 actPers3 hh2AduCh hh3Adu hh3AduCh age30 44 age45 59 socInact actPers0 hhSing age60 actPers1 quint3 quint4 hh2Adu quint1 quint2 hhSingCh quint5 age0 29 5 Clusters 1 1 1 1 1 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 5 5 4 Clusters 1 1 1 1 1 1 1 1 1 2 2 2 2 1 1 1 1 3 3 3 4 4 3 Clusters 1 1 1 1 1 1 1 1 1 2 2 2 2 1 1 1 1 3 3 3 1 1 2 Clusters 1 1 1 1 1 1 1 1 1 2 2 2 2 1 1 1 1 2 2 2 1 1

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Empirical Analysis
Cluster analysis

Clusters in differences? Five clusters:


1. 2. 3. 4. 5. Young and rich Low socio-economic status Middle-classe income earners Economically inactive and elderly Classical role models: households with children, mostly middle-aged, actively earning incomes

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Empirical Analysis
Driving forces: Principal component analysis

Step 1: varimax rotation (orthogonality imposed, makes interpretation easier) Step 2: promax rotation (orthogonality relaxed, less restrictive decomposition) Results: In both cases, two factors stand out as driving forces of the bulk of variance

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Empirical Analysis
Driving forces: Principal component analysis

Figure: 1st and 2nd PC (varimax and promax rotation)

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Empirical Analysis
Driving forces: Principal component analysis

Common driving forces in differences? Mainly two principal forces: According to loading factor analyis:
1. The rst one is associated with low income households (versus high income households); 2. the second one is associated with households with children (versus households without children)

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Conclusion
Country-by-country analysis

On the national level:


The panel of household-specic ination rates in each country seems to be driven by one single factor (not necessarily coinciding with the HICP ination rate); The remaining part of the cross-sectional variance in the panel is driven by stationary idiosyncratic components, i.e. the part not explained by the single common factor in each country is mean-reverting (good news: household ination rates do not diverge permanently without bounds from the common factor); Evidence for a single co-integration vector (mean-reversion of the household-specic ination rates towards the representative household ination rate); The adjustment speed towards the representative household is low persistence of deviations is high;

Even if there is little concern about a long-run stable distribution, at least in the short- to medium run deviations tend to last

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Conclusion
Pooled panel analysis

On the pooled level Small but signicant differences in the deviations of household-specic ination rates from the reference rate mainly along income and education levels. We can separate ve clusters and we identify two main driving forces for the differences in the overall panel. These driving forces are related to low-income households and households with children. Uncomfortably, our results suggest that some of the economically more vulnerable parts of the population may be subject to group-specic ination dynamics resulting in systematic higher-than-average ination.

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To-do-list
Data update How sensitive are the results with respect to 1999 HBS wave versus 2005 HBS wave? Identify economic factors for dispersion in ination rates. House prices, supply shocks, oil price, demand shocks Income effects and substitution effects Link ination experience with ination perception/ expectations of different groups Link ination experience with consumption/ savings data Decompose the paper in different parts Check differences in ination volatility

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