Inflation Won't Just Hurt the Rich

The poor and middle-class could suffer as well.

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By Stan Veuger and Daniel Shoag

Over the past few months, pundits and policymakers alike have expressed increasing concern about rising price levels. Sure, some of these analysts have been sounding the inflation alarm bells for over a decade. Others construct their own inflation statistics by focusing only on items that have increased in price while ignoring the prices of goods that have gotten cheaper. But this time, economists who have been otherwise comfortable with loose fiscal and monetary policy are expressing some unease. Even überdove Paul Krugman believes that “it makes more sense to worry about inflation this time around.”

To be clear, when we say inflation we mean an increase in aggregate consumer prices. That is quite different from changes in relative prices. Over the past few months, there has been a series of freak-outs over specific items—lumber, Christmas garlands, used cars, and others. But even stark changes in relative prices can be useful: They tell consumers that perhaps now is not the time to make a purchase, and they tell sellers and producers where opportunities lie. Instead, what we are interested in here is the price of the full bundle of goods and services consumers purchase.

We are in fact seeing higher inflation readings than expected even a few months ago. This may largely be the result of transitory factors like imperfections in the American Rescue Plan and supply chain adjustments, but there is significant uncertainty. And even these transitory factors can feed into expectations of future inflation. Such expectations, in turn, can be self-fulfilling if they incentivize workers and firms to raise their wage demands and prices preemptively.

It is important to be clear-eyed about the potential consequences. Ardent full-employment advocates often shrug off inflation concerns (loose fiscal and monetary policy are often seen to generate both) and highlight the advantages of an economy that is running hot. But inflation generates risks for the poor and the working class as well as for the rich. 

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There is a traditional view, for lack of a better word, that high inflation is particularly costly to those who own capital—in other words, the rich. The idea is that the capitalist class derives much of its income from interest (on loans, bonds, bills, etc.) and rental payments and that those are set in fixed amounts (called “nominal” amounts). When inflation occurs, the value of the nominal amount is reduced. For example, if a bond provides a $1 annual payment in perpetuity, that payment becomes less valuable when the prices of goods and services rise. This hurts the owners of fixed-income assets and helps the debtor class.

The most famous manifestation of this line of argument is perhaps William Jennings Bryan’s 1896 “cross of gold” speech, in which he argued that the gold standard was not inflationary enough and unfairly harmed debtors facing nominal obligations, in particular farmers with mortgages. 

Unfortunately for those who see high inflation as a way to redistribute wealth to the poor, the traditional view does not account for what are called “real” assets—think real estate, equity in businesses, or any other asset that preserves its value when prices go up. These real assets, also disproportionately held by the capitalist classes, are more resilient. Given how common these types of assets are—80% of the wealth of the top 10% comes from equity stakes in public and private businesses—rising prices do little to redistribute wealth.

Of course, if you have a fixed-rate mortgage, you still benefit from moderate levels of inflation in the same way the farmers in Bryan’s speech did. But inflation’s impact on that form of debt ownership is more likely to benefit middle-class than low-income households. After all, the top 20% of the income distribution holds almost half of all mortgage debt, and the top 50% of the income distribution holds about 75%. In the aggregate, moderately elevated inflation probably transfers some wealth from the very wealthy to the upper-middle class without doing much for the lowest-income folks.

Inflation would also erode the value of poor and working-class people’s wages. If wages do not adjust to price increases, workers’ purchasing power will be reduced. This is particularly true for those minimum-wage workers who earn exactly the minimum wage. In fact, periods of high demand—boom times—may well leave already employed workers with lower rather than higher real wages, as happened most famously in the interwar period.

In addition to these direct hazards of rising inflation, the monetary policy response could cause even more harm to people across the wealth and income spectrums. If inflation triggers a Federal Reserve response that is too aggressive or too late, it will lead to a recession. Many people will then find themselves out of work, with dramatic consequences that could include large earnings losses (some of which will become permanent), mental health problems, and increasing crime.

Alternatively, if the Federal Reserve does not respond and inflation escalates, the result could be chaos: households and firms will find it dramatically harder (because of very fast changes in prices) to decide correctly what to buy, how much to save, and where to invest. The economy could cease to function altogether. Fortunately, we can be extremely confident that this kind of breakdown, which we have seen in Venezuela, will not happen here, as the Federal Reserve will intervene well before we approach this territory.

That is not to say that there is no trade-off involved in aggressively policing inflation. Full employment, in particular, is extremely desirable because it is often workers from the most vulnerable groups in society who struggle to find work until overall levels of unemployment are very low. But just as we should not ignore those benefits of inflation, it would be a mistake to ignore the potential costs.

Stan Veuger is a resident scholar in economic policy studies at the American Enterprise Institute for Public Policy Research.

Daniel Shoag is an associate professor of economics at Case Western Reserve University’s Weatherhead School of Management.