Low-income households saw steeper grocery price inflation - Bank of Latvia economists

RIGA - In percentage terms, prices of cheaper goods have increased more than of the expensive products, which means that low-income households, which typically buy cheaper food, have seen steeper grocery inflation than well-off households, Bank of Latvia economists Dans Staermans and Boriss Silvestrovs write on the central bank's analytical website macroeconomics.lv.

The economists noted that in 2022 and 2023, prices in many parts of the world went up at a rate not seen for many years. Yet, there were noticeable differences among various goods and services, and among countries. In the European Union (EU), the Baltics, including Latvia, faced one of the most dramatic inflation rates.

In Latvia, like in most other EU member states, inflation has been largely driven by skyrocketing energy and food price, but inflation can be experienced very differently by different households. The average inflation figure calculated by statisticians for an EU is a useful indicator of changes in the economy, but each household's consumption and the expenditure needed to meet is different. 

"A two-children family living in Latvia and spending most of its income on essential needs like heating, electricity, and food (i.e., a low-income family) was hit by the rising prices much harder than, say, an affluent working-age couple living in Madrid. Even if the latter live in a bigger apartment and spend more on electricity and groceries, this spending likely makes up a smaller portion of their budget, and any increase in such spending is less noticeable. They can also cut back on it by switching from premium brands to regular ones or maintain the previous consumption by using their savings – a freedom that is unlikely for a low-income family," the Bank of Latvia economists say in their article. 

The economists stress that measuring the differences in inflation rates experienced by the rich and the poor is important because it allows us to better understand social inequalities and design targeted support mechanisms. 

Analysis by the European Central Bank's (ECB) economists reveals differences between the expenditure weights of the monthly HICP inflation data and those of the Eurostat Household Budget Survey (HBS) data (the survey focusses on households of various income groups and is conducted every five years). According to ECB's findings, in September 2022, the annual effective inflation rate for the bottom income quintile exceeded that of the top quintile by about 2 percentage points.

The Bank of Latvia economists noted that online shopping boomed in Latvia during the pandemic. For monitoring and research, Latvijas Banka started recording online shop prices of two major supermarkets in 2021. These data do not tell us what each person buys, but they show the daily price changes for many products. Each month, economists focused on the 10 percent highest and 10 percent lowest prices in each category. The economists used the first month for which data were available - March 2021 - as a starting point.

The economists concluded that both cheap and expensive products gradually became significantly more expensive in 2022, with prices rising by at least 30 percent compared to the base price. Prices of cheap goods peaked in March 2023, while prices of expensive goods peaked in January of the same year. It was also concluded that initial prices matter in an inflationary context. By March 2023, the most expensive prices had increased by 33 percent, whereas the cheapest by 53 percent, a difference of 20 percentage points. After this peak, the prices of the cheapest products started to fall, while the prices of the most expensive goods remained broadly stable. Thus, a distinct peak for the cheapest goods was recorded in March 2023. 

As for the reasons of such different inflation trends, economists argue that one reason could be that people who buy pricier items have more options. If their favorite expensive item becomes too costly, they can just switch to something cheaper. But those who are already buying the cheapest option are stuck with it. This means that sellers can raise prices for cheaper products more confidently, knowing that people will still buy them. Another reason may have to do with the size of profit margins. If stores enjoy higher margins when selling expensive items, they need not raise prices as much to preserve absolute profit when their costs go up. 

This explanation would still require retailers to sacrifice some of the relative profit (margin), which could be the case given the remarkable rate of inflation and price competition between the supermarkets. Moreover, a significant sacrifice in the upscale segment could explain why expensive items have not seen price drops with a sort of "margin recovery".

The web-scraped data used by Staermans and Silvestrovs in their analysis  reveal that food prices may be going up quicker for those earning less compared to those earning more. As less affluent households already allocate a larger share of their income to food, they are double-squeezed – both by their spending allocation and by prices.

"For academics, our results provide another piece of evidence that officially reported HICP inflation figures may mask important differences in spending patterns and the realized changes in costs of living faced by households with different income levels, especially during the periods of high inflation. For policy makers, they highlight the importance of targeted support measures. Indeed, it appears that those having no choice but to accept the higher inflation are in a different position than those having the alternative of switching gears," the Bank of Latvia economists conclude.