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Friday, June 17, 2005

Study: Does inflation vary with income?

1992 to 2004

Inflation varied with income at certain points in time between 1992 and 2004, according to a new study. The highest and lowest income groups took turns experiencing higher price increases, but at the end of the 12-year period, their total inflation rates were almost on par.

This study examined the inflation rates of the 20% of households with the lowest incomes and the 20% with the highest incomes between January 1992 and February 2004.

Between January 1992 and February 2004, prices rose 24.7% for the one-fifth of households with the lowest incomes, or an annual average rate of 1.86%. On the other hand, they increased 24.4% for the one-fifth with the highest incomes, or 1.83% a year on average.

Beginning in early 1994, lower-income households experienced two years of relatively lower inflation. Then after January 2001, conditions reversed and the higher-income households saw relatively lower inflation.

Over the entire 12-year span, long-term price trends of a few items actually favoured higher-income households. In large part, this was because of constant lower-than average price increases of certain items, such as household electronics and computer equipment. These figure more prominently in the expenditure baskets of higher-income households.

However, at the national level, the effect of these long-term price trends was balanced out by the impact of other items such as rent, whose low average price increases benefited lower-income households.

The Consumer Price Index (CPI) is widely used to monitor changes in the general level of consumer prices, or in other words, the rate of inflation. Since the purchasing power of money is affected by changes in prices, the CPI is a useful tool for virtually all Canadians.

Taking turns experiencing lower inflation

In general, between January 1992 and January 2001, lower-income households experienced lower rates of inflation than higher-income households.

As a result, by January 2001, the typical lower-income household in Canada would have experienced an overall CPI increase of 1.53% per year, while the average higher-income household saw higher inflation at 1.65%.

In early 2001, however, conditions reversed, and higher-income households experienced lower inflation. Their rate was an average of 2.07% per year between January 2001 and February 2004, compared with 2.61% for the average lower-income household.

However, by February 2004, the overall inflation rates of lower- and higher-income households in Canada between 1992 and 2004 were almost equal.

Large differences in spending patterns

These two sets of households experienced differences in overall price increases because they have different spending patterns.

In other words, when a particular item increases in price, its impact is different for two distinct groups if they consume it in different amounts relative to their overall spending.

For example, lower-income households spend a much larger share of their expenditures on food purchased from stores. Higher-income households tend to spend a larger share than other groups on food at restaurants.

In addition, few higher-income households are renters, while few low-income households are homeowners. For this reason, their shelter-related expenses differ, with lower-income households paying on average 23.5% on rent and tenants' expenses compared to only 3.7% for the higher-income group.

Lower-income households also spend a smaller proportion of their expenditures on utilities, such as home heating and water, because these are sometimes included with rent.

Lower-income households saw lower inflation until 2001

From January 1992 to January 2001, lower-income households in Canada experienced relatively lower inflation — mostly because of smaller price increases for rent, food in stores and tobacco prices. At the same time, higher prices for automobiles and gasoline raised inflation for higher-income households.

However, lower price increases for household electronics, clothing and mortgage interest payments moderated the CPI increases of higher-income households.

On average after 1992, rents increased at a slower rate than the overall CPI, slowing the growth in the inflation rate for lower-income households. However, some of this difference was countered by slow price increases of mortgage interest payments, which increased by just over 10%, while the overall CPI increased by almost 17%.

This had the impact of tempering CPI increases of mortgage-paying households, which are very rarely found in the lowest income quintile.

Automobile prices increased rapidly in the years leading up to 1998, when they levelled off. By January 2001, car prices across Canada were over 25% higher compared to January 1992, which increased the inflation rate for higher-income households compared with lower-income households.

After January 2001, the situation changed and lower-income households experienced higher price increases, largely due to higher tobacco prices starting in 2002. By February 2004, tobacco prices were almost 80% higher compared with January 2001, which pushed up inflation for lower-income households by about 1.3 percentage points compared to the higher-income group.

Continuing lower rent increases, however, helped moderate inflation in lower-income households.

The price of automobiles, an item that figures more prominently in the expenditure basket of higher-income households, decreased slightly from January 2001 to February 2004, lowering inflation for higher-income households during this period.

Provincial differences larger

From January 1992 to February 2004, differences in the inflation rates of higher- and lower-income households within provinces were smaller than the differences in inflation among the provinces themselves.

This is because the price movements of some important items, such as tuition fees, utilities (gas, electricity), mortgage interest payments and car insurance differ significantly from province-to-province. Some of these differences were also due to the spending patterns of higher- and lower-income households, which change according to province.

Because of these price factors and spending pattern differences, total inflation rates for households of various income groups differed among the provinces between 1992 and 2004. In British Columbia, Alberta and Saskatchewan, relatively lower-income households experienced higher price increases, while the opposite was true in Ontario and Quebec.

One example of different price movements is that of mortgage interest payments, whose prices did not increase evenly across the country. For example, in Quebec, the mortgage interest payments increased by almost 34% between January 1992 and February 2004, while Ontario homeowners experienced an increase of less than 14%. On the other hand, homeowners in British Columbia saw their mortgage interest payments fall by 12% on average.

The differences were due not so much to differences in mortgage rates as in house prices and the distribution of the housing stocks.

Definitions, data sources and methods: survey numbers, including related surveys, 2301 and 3508.

The analytical article Does Inflation Vary with Income? 1992 to 2004, no. 30 (11-621-MIE2005030, free) is now available online in the Analysis in Brief series (11-621-MIE).

For more information, or to enquire about the concepts, methods or data quality of this release, contact Radu Chiru (613-951-3998), Prices Division.

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Date Modified: 2005-06-17 Important Notices