Australia is living through its worst inflationary episode since the late 1980s. High inflation can affect inequality, because not all types of households are hit in the same way when prices are rising quickly.

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First, different household types buy different goods and services, so faster growth in some prices will hit the households that buy more of those goods and services harder.

Second, different types of households have different capacity to absorb the ‘shock’ of higher prices – including by reducing their discretionary spending, eating into their savings, or drawing down on their assets.

Third, and less directly, in periods of high inflation, nominal income growth can differ across household types. This may reduce the capacity of some to manage the shock.

Our analysis finds that recent high inflation has disproportionately hit low-income households.

We find that the rates of effective inflation have been similar for most household types through 2022 and 2023, because price rises have been broad-based.

High growth in the prices of essentials such as food and energy have disproportionately hit lower-income households. On the other hand, high growth in the prices of some discretionary items, such as holiday travel, have hit high-income earners harder.

Effective inflation has been higher for homeowners than renters, because housing construction costs have been rising fast. However,

given most homeowners have not purchased a newly constructed dwelling recently, this overstates the impact on most homeowners. Further, the squeeze on renters from recent high growth in advertised rents will take time to flow through to the Consumer Price Index.

But households differ in their capacity to absorb high inflation.

Lower-income households have less ‘fat’ in their spending, as do low-wealth households, renters, and people on government payments. This means less scope to reduce spending before spending on essentials is squeezed.

Low-income households also have fewer savings and fewer liquid assets, and so have less capacity to draw on their savings to maintain their consumption when prices rise.

On the other hand, lower-income households have had faster overall average income growth. But this is partly because some low- income earners are working more hours.

Overall, high inflation has hit many low-income Australians particularly hard. Indicators of financial distress are much higher among low-income households than for others.

The disproportionate impact on the most vulnerable is another reason for the Reserve Bank to shoot for low and stable inflation. And it also suggests any government response to mitigate the effects of high inflation should be targeted to the most vulnerable.

Finally, our work highlights the need for expenditure data to be made available more quickly, so we can better understand any distributional impacts of inflation.

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