Government can help to shield the poor from inflation
September 26, 2005
 By Alide Dasnois
The claim that inflation hits poor households hardest is often used to counter demands for lower interest rates.
Low interest rates, the argument goes, might help boost investment and help tackle poverty by creating jobs, but at the same time they allow inflationary pressures to build up. And the poor, like those on fixed incomes, suffer the most from high inflation.
But though it is true that poor households are less able than richer households to adjust their spending to cushion themselves against price rises, it is not necessarily true that poor households always experience higher rates of inflation.
In an article in the Reserve Bank publication Labour Market Frontiers, University of Cape Town researchers Haroon Bhorat and Morné Oosthuizen examine the effects of inflation on the poorest 40 percent of urban households between 1997 and 2002 - a period when inflation was relatively high.
They find that poor households did not face higher inflation than others: nearly half the time, in fact, the inflation rate facing poorer households was lower than that facing better-off households.
"Poor households do not consistently experience higher rates of inflation than higher-income groups," Bhorat and Oosthuizen write.
"The answer to the question of who is experiencing the highest rate of inflation at a given time will depend on the structure of inflation at that time."
Examining the main drivers of inflation for poor urban households, they were surprised to find that two basic services - water and electricity - topped the list. House rent was the third-largest contributor and other items included paraffin, refuse removal and public transport.
Prices of all these items, the researchers point out, are determined at least partly by the state.
Conclusion: the government can best shield poor households from the effects of inflation by keeping down the prices of these goods and services.
"Government, in some form or another, is able to affect the prices of seven of the top 14 items driving inflation for poor households over the period.
"Water and electricity were consistently ranked first and second ... as the largest contributors to poor households' inflation. Similarly, government is able to influence the prices of paraffin, assessment rates, refuse removal, sanitary services and public transport to varying degrees.
"The finding suggests significant scope for the state to shield poor households from excessive inflation."
A determined policy of low prices for water, paraffin, house rent and other items that feature high in the budgets of poor households would have the bonus of slowing down targeted inflation, opening up possibilities for interest rate cuts.
High administered prices of water, electricity and such items hit the poorest households twice, explains Iraj Abedian of Pan African Investment and Research Services. First, because these items are a higher proportion of their budgets than of the budgets of wealthier households, big increases in prices of goods such as water are hard to swallow.
Second, hefty increases in administered prices - which make up nearly a quarter of the consumer price inflation measure used for inflation targeting - prop up the general inflation rate, discourage cuts in interest rates and slow down the creation of job opportunities that are desperately needed by the poor.
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