Inflation, Real Income Levels, and Benefit Uprating

Changes in the real income levels of households arise through changes in nominal incomes or changes in price levels. We have alluded to this issue at several points in the book, particularly in the context of trends in absolute poverty rates—those calculated using a low-income cut-off held fixed in purchasing power terms—but the point is a more general one.

One of the reasons why real incomes did not fall during the period of the GR is because, in most of the countries that we are considering, inflation rates were falling. This is shown in Table 2.4. For almost all of the 21 OECD countries, the consumer price index rose by more than 3% between 2007 and 2008; the rise was 3.3% for Euro area countries, 3.6% for the UK, and 3.8% for the USA. However, the change between 2008 and 2009 was only 0.3% for Euro area countries, 2.2% in the UK, and -0.3% in the USA. Prices rose again between 2009 and 2010, but not at the rate they had risen by two years earlier.

For certain groups in the population, changes in inflation also lead to changes in nominal incomes. This may describe the case of employees with automaticallyTable 2.4. Change in consumer prices from previous year (%), 2008-10, by country

Source: OECD (2011 b: annex table 18).

Notes: Tableentries show the percentage change from the previous year in the relevant national consumer price index, i.e. the harmonized index of consumer prices (HICP) for Euro area countries, Euro area, and the UK (where the index is known as the 'CPI'). The Swedish consumer price index includes mortgage interest costs.

indexed pay awards, but this form of labour contract is relatively rare. More important in times of recession is the way in which countries change ('uprate') cash benefitpaymentstotakeaccountofinflation. (How income tax schedules are indexed is also important, but we focus on benefits here.) In many countries, there are no automatic benefit uprating formulae; by contrast, the UK uses formulae that uprate most means-tested benefits automatically each year by an amount that depends on the increase in consumer prices in the previous year.

Marchal, Marx, and Van Mechelen (2011), discussing EU countries, find that 'during the years prior to the crisis, gross benefits generally maintained their purchasing power. In more than a few countries, benefit levels even increased (somewhat) more than consumer prices. Nevertheless, there are some important exceptions, mainly in those countries where no automatic indexation procedure exists' (2011: 8). (The exceptions largely concern new member states.) However, the authors also make the point that having a discretionary uprating process does not necessarily lead to erosion in the real value of benefits. Inter alia, they cite the case of Ireland, which is discussed in more detail in Chapter 4. Marchal, Marx, and Van Mechelen also find that '[i]mmediately after the onset of the crisis, real benefits generally increased____The deceleration in nominal growth

[of social assistance benefit levels] seen for 2009-2010... has led in some countries to a small loss in purchasing power. However, this decrease seems very much in line with trends in real benefits in pre-crisis years' (2011:8). The case of the UK is discussed in detail in Chapter 7. It points to not only the cushioning impact on real incomes of automatic but lagged uprating in times of falling inflation, but also the downward pressures on real benefit levels in times of rising inflation rates (post-2010).