Who bears the costs of inflation? Euro area households and the 2021-2023 shock

Layer 1: Overview

This paper measures the heterogeneous first-order welfare effects of the 2021-2023 inflation surge across households in the four largest euro area countries (Germany, France, Italy, Spain). Motivation: euro area headline HICP inflation peaked at 10.6% (year-on-year) in October 2022, driven mainly by energy and food prices following Russia’s invasion of Ukraine; cumulatively over 2021-23 the price index rose roughly 14% in France and Spain, 16% in Italy and 20% in Germany. The classic question—who wins and who loses from surprise inflation, and through which channels—is the focus.

Method: The authors build a tractable two-period overlapping-generations framework and use the envelope theorem to decompose the “money-metric” welfare change (in euros) into four additive, observable components requiring no functional-form or structural-parameter assumptions: (1) a direct component (raw inflation before fiscal support, holding wages and asset prices fixed; captures heterogeneous consumption baskets and the Fisher revaluation of net nominal positions, labor income, dividends and capital gains); (2) an unconventional fiscal policy component (ad-hoc energy price interventions and transfers); (3) an indirect component (short-run responses of nominal wages, pensions, taxes/fiscal drag, and asset prices); (4) a long-run adjustment component (relative prices returning to pre-shock ratios). They combine micro data—Household Budget Survey (2015 wave) for expenditure shares, HICP micro data for good-specific price changes (20 COICOP-based categories), the 2017 Household Finance and Consumption Survey (HFCS) for budget-constraint components, the Bruegel dataset for fiscal responses, and IMF (Dao et al. 2023) counterfactual prices—with event-study/high-frequency identification (on German HICP release days) for wage, pension, house, stock and bond price responses. Households are sorted into 15 groups: three age classes (25-44 young, 45-64 middle-aged, 65+ retirees) and five consumption (permanent-income proxy) quintiles per country. Welfare is expressed as a share of triennial (3-year) disposable income.

Main findings: (i) Average country-level welfare losses were sizable and heterogeneous: around 3% of triennial income in France and Spain, 7% in Germany, and 9% in Italy. (ii) The episode resembles an age-dependent tax: retirees lost up to 14% (German and Italian high-income retirees), while roughly half of 25-44 year-olds were net winners; young French households gained up to 7% (about EUR 4,000 on average), young Spanish broke even; middle-aged households lost roughly 2-11%. Overall about one quarter of euro area households were net winners. (iii) Losses were quite uniform across consumption quintiles because rigid (sticky) rents hedged the poor; excluding rents, the poor suffer more due to higher energy/food exposure. (iv) Nominal net positions (NNP) were the key driver of cross-household heterogeneity—retirees hold large positive nominal assets, the young hold nominal mortgage debt. (v) Energy prices generated vast individual-inflation-rate variation, but unconventional fiscal policy (especially energy price caps, more so in France where it cut inflation ~2 p.p.) shielded households, reducing first-stage welfare costs by about one-fifth on average. Estimated asset-price elasticities to a 10% inflation surprise: house prices -1.38% (beta x delta = -3.995 x 0.035 = -0.138), stocks -0.410, bonds -0.726. Pensions, being indexed, rose faster than wages; fiscal drag taxed away gains in Italy and Spain (unindexed brackets), much less in France/Germany. The counterpart of household losses is a large government gain from eroded real public debt: governments in France, Italy and Spain were net winners (Italy +4.5 to 5.1% of triennial GDP), while Germany roughly broke even. Policy implication: in a monetary union where monetary policy cannot address country-specific dynamics, fiscal policy was crucial; and redistributing government inflation gains to households could substantially offset their losses.

Layer 2: Deep Dive

What is the identification/measurement strategy and what are its main threats?

The core strategy is an envelope-theorem decomposition that yields analytical ‘sufficient-statistic’ formulas for money-metric welfare change, requiring only observable budget-constraint quantities and price changes—no structural parameters or functional forms. The key assumption is that, to first order, substitution in consumption baskets and portfolio rebalancing after the shock have only second-order welfare effects, so observed pre-shock quantities (2015 HBS shares, 2017 HFCS positions) can be used. Four structural assumptions define the shock: (1) it is unanticipated; (2) the price-level jump is permanent but inflation is temporary (returns to zero from t=1); (3) the shock is long-run neutral in aggregate and across the distribution—all nominal variables and relative prices realign one-to-one with the new price level by t=1; (4) the government budget constraint accommodates either via the price level (active/FTPL) or via future real surpluses (passive). For asset-price responses they use high-frequency identification: regressing daily REIT, stock and bond returns on the inflation surprise (daily change in 1-year inflation-linked swaps) on German HICP release days, controlling for stock returns. Main threats: the first-order/second-order approximation could fail if substitution effects are large (the authors note that pre/post high-frequency micro data—unavailable to them—could test this); the use of 2015 expenditure shares and 2017 balance sheets to represent the pre-shock state; reliance on counterfactual price series (IMF, OMIE) for what prices would have been absent intervention; and the assumption that relative prices fully return to pre-shock ratios in the long run.

What are the four channels and how are they distinguished empirically?

(1) Direct component: raw inflation effect on cost of living before fiscal support and before wage/asset-price adjustment; split into average inflation, the ‘pi difference’ from heterogeneous baskets (C), net income/labor-income purchasing power (Y), net nominal positions (NNP), and dividends+capital gains (K). (2) Unconventional fiscal policy (UFP): energy price interventions (changes in good-specific tax/subsidy wedges, requiring counterfactual no-intervention price indices) plus ad-hoc transfers to households. (3) Indirect: short-run changes in nominal wages, minimum wages, pensions, fiscal drag, and asset prices (house, stock, bond) plus the direct effect of monetary-policy-driven interest-rate changes on deposits and debt. (4) Long-run: welfare from relative prices realigning to the new price level, discounted to t=0. They are computed sequentially in stages so each component’s contribution is isolated. NNP is the dominant driver of age heterogeneity; Y is the largest single contributor to losses but is fairly uniform across groups; C matters mainly for poor elderly in Italy and Spain.

What heterogeneity is documented?

Age is the most pronounced dimension: retirees lose most (driven by large positive nominal asset holdings), the young least (often net winners via mortgage debt revaluation). German and Italian retirees lost up to 14% of triennial income; high-income retirees lost more than EUR 10,000 on average. By contrast, the consumption-quintile (permanent-income) gradient is weak because sticky rents hedge low-income renters; excluding rents reveals a negative inflation-income gradient (poor face higher inflation via energy/food). Cross-country: Italy highest cost (~9%), France lowest (~3%), due to (i) bigger raw price shock in Italy (energy import dependence/market structure), (ii) more effective fiscal offset in France, (iii) nominal wages lagging inflation much more in Italy, (iv) Italian middle-aged/elderly holding larger nominal positions while the young borrow less than in France. Within-bin heterogeneity (homeowners with mortgages vs renters) means about a quarter of households are winners overall; more than half of the young in France and Spain, ~50% in Germany, ~30% in Italy, and ~50% of Spanish retirees (extensive pension indexation) are winners.

What role did unconventional fiscal policy play?

Fiscal interventions reduced first-stage welfare losses by about one-fifth on average across countries and household types. Energy price caps were more important than transfers, especially in 2022 when caps were active in all countries. In France, interventions reduced the measured inflation rate by about 2 p.p.; in Italy interventions came ex-post via bonuses/transfers and so did not lower recorded inflation. Retirees benefited most, consistent with their higher energy/food shares and targeted measures. Government fiscal support outlays were approximately 1% of triennial GDP in all four countries, though in Italy and Spain a larger share (above 35% of costs) went to firms versus 14% (Germany) and 5% (France).

How are asset prices treated and what are the estimated elasticities?

House prices: a two-step approach—daily REIT (FTSE EPRA NAREIT Eurozone Residential) returns regressed on inflation surprises (beta = -3.995 on the swap surprise) on German HICP release days, then quarterly house-price returns (2006Q1-2023Q4) regressed on lagged REIT returns (delta = 0.035); the product beta x delta = -0.138 means a 10% inflation surprise lowers house prices ~1.38%. Stock and bond elasticities are larger and negative: -0.410 and -0.726 respectively. The asset-price channel is quantitatively negligible in welfare terms because house elasticity is small and stock/bond holdings are concentrated only at the very top of the consumption distribution. Housing and stocks are therefore not good inflation hedges when inflation has a large cost-push component.

What about wages, pensions, and fiscal drag in the indirect channel?

Nominal wage increases were modest, generating a welfare gain of only about 3% of disposable income against a direct loss on nominal wages of about 9.5%. Wages rose faster in France (sectoral agreements, over 4% vs 2-3% elsewhere) and for low-quintile German workers (large minimum-wage rise in October 2022). Pensions, being indexed to past inflation, grew more than wages in all four countries, so retirees gained substantially from the indirect channel, especially in Spain (pensions up 9.5% for most pensioners in 2023). However, fiscal drag (unindexed tax brackets in Italy and Spain) taxed away nominal gains—up to 2.5% for higher-quintile pensioners—whereas France and Germany had near-real-time bracket indexation, so drag was small. Higher ECB interest rates (tightening from July 2022) raised mortgage payments for young Spanish households with adjustable-rate mortgages, partly wiping out their NNP gains; the effect was small elsewhere (fixed-rate mortgages, limited deposit-rate pass-through).

What does the sectoral (government and foreign) analysis show?

Using Euro Area Sector Financial Accounts (2017), the household sector holds positive net nominal positions (total NNP/triennial GDP: 0.28 Germany, 0.31 France, 0.35 Italy, 0.13 Spain), governments hold negative positions, and the foreign sector is a creditor against all except Germany. From the NNP channel alone the household sector lost (as % of triennial GDP): -3.8 Germany, -2.9 France, -3.9 Italy, -0.5 Spain; governments gained +3.5, +4.8, +7.5, +4.5; the foreign sector gained +0.3 in Germany but lost -1.9, -3.6, -3.9 in France, Italy, Spain. Adding fiscal drag (revenue), fiscal support cost (~1% GDP), higher pension cost (~1% GDP, peak 1.7% Italy), and higher government energy purchase cost, total government gains were: Germany -0.6 to +0.5 (roughly breaks even), France +1.3 to 2.1, Italy +4.5 to 5.1, Spain +1.6 to 2.2% of triennial GDP. Cross-country differences in government gains are driven mainly by the outstanding stock of public debt. Redistributing these government gains to households could substantially offset household losses.

How does this paper relate to and differ from prior work?

It applies the envelope-theorem money-metric approach used by Auclert (2019), Slacalek et al. (2020), Fagereng et al. (2022) and Del Canto et al. (2023), but studies a specific historical episode as an event study rather than identified shocks. It builds directly on Cardoso et al. (2022), who quantify the direct channel for Spain using bank-account data, by adding the other three channels (fiscal, indirect, long-run) and covering four countries. It contributes to the inflation-heterogeneity literature (Kaplan-Schulhofer-Wohl, Jaravel, Hobijn-Lagakos, Argente-Lee) by documenting inflation-rate differentials an order of magnitude larger than pre-pandemic US estimates, and confirms Doepke-Schneider (2006) that age is the key dimension via life-cycle net nominal positions. Unlike fully specified HANK models (Pugsley-Rubinton, Olivi et al., Yang), the sufficient-statistic approach cannot evaluate policy counterfactuals. Most contemporaneous euro-area papers stop at measuring differential inflation; this one quantifies full welfare.

What are the main caveats and robustness considerations?

The framework is first-order: it assumes consumption and portfolio adjustments have only second-order welfare effects, which the authors flag as testable with high-frequency micro data they lacked. Survey-based (HFCS) nominal asset measures are 2-3 times smaller than financial-account measures because surveys undersample the very rich, so the Section 4 micro results best represent the population excluding the wealth top. Expenditure weights come from the 2015 HBS (judged stable using 2005/2015 HBS and credit-card evidence); inflation expectations (0.4-1.7%/year) come from Consensus Economics early 2021. A robustness note: assuming 0.75%/year trend productivity growth (so part of nominal wage rises reflects trend, not catch-up) increases welfare losses by roughly 1.5% of disposable income. The retiree/young housing trade is modeled as selling/buying one tenth of housing (3/30 over the 3-year long run). The conclusion notes the episode coincided with high pandemic excess savings that cushioned purchasing-power erosion, and that the inflation tax effectively redistributes from retirees to the young, partially offsetting future fiscal adjustment.

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