Beyond the headline: How personal exposure to inflation shapes the financial choices of households

Households are exposed to different rates of inflation because they buy different things, and using anonymised quarterly bank-account records for 89,507 individuals at one of Estonia’s leading commercial banks over 2005-11, this paper finds that individual consumption spending responds to that personal exposure over and above the headline rate: one percentage point of higher quarterly personal inflation raises real consumption spending by 1.4%. The account records run from Q4 2004 to Q4 2011, and the group-specific inflation rates are imputed onto them from the Estonian Household Budget Survey; once the offsetting drag from lower real income and lower real wealth is netted out, the total effect stays positive and close to 1%. Because time fixed effects absorb headline inflation by construction, the estimate is the response to price changes experienced personally as a deviation from the headline rate. The authors argue their small-open-economy setting – where inflation is largely driven by shocks from abroad and a currency board tied domestic interest rates to rates set elsewhere – lets them establish a causal link from experienced inflation to consumption, though they are explicit that imputing baskets at the level of 12 broad expenditure categories compresses the true dispersion of inflation, so their coefficients should be read as lower bounds. The extra spending is financed by drawing down term deposits and by taking on consumer loans and overdrafts, and it is markedly weaker for individuals with little liquid wealth, with more existing debt, or with heavier debt-service burdens – the pattern that heterogeneous-agent models predict when binding constraints block the shifting of consumption across periods.

Christoph Basten | Macro Paper Warehouse

Beyond the headline: How personal exposure to inflation shapes the financial choices of households