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SCIENCE FOR POLICY BRIEF

Inflation and its social consequences – The case of Nordic and Baltic countries

Balint Menyhert, Joint Research Centre, European Commission.

Foreword

The Nordic countries have a common vision of becoming the most sustainable and integrated region in the world.

Secure, affordable, and clean energy is fundamental to realizing this.

A confluence of factors has caused European energy and commodity prices to rise. Annual energy inflation in Europe rose throughout 2022, pushing headline inflation to record highs. Consumers’ budgets have been put under pressure, sending energy bills to record highs.

In light of the current unprecedented energy prices and geopolitical risk, energy poverty has come on the agenda in our countries – primarily due to high energy prices, but also because new EU regulations require action to tackle this issue.

Ensuring affordable energy for all households, and preventing energy poverty, has therefore become a major challenge that requires immediate action in the Nordic countries.

The Nordic and Baltic countries have a unique and long-standing energy cooperation, which has created a solid foundation for the development of a sustainable and secure energy supply in the region. Yet, price shocks for consumers are a relatively new phenomenon in the Nordic countries, which have historically benefited from energy prices. Two key questions are raised: How have rising energy prices affected households in the Nordic countries?

How have the Nordic countries approached consumer protection versus our Baltic or EU counterparts?

Developing indicators for and measuring energy poverty can support a more targeted approach that protects energy-poor consumers from unaffordable energy bills, while preserving incentives to save energy.

Building on new collaborations between Nordic Energy Research and the Joint Research Centre of the European Commission, the statistical analysis in this short report by Balint Menyhert may help us take stock of the social situation, better understand the similarities and differences between our countries, and support us in designing and implementing effective policy measures for stronger cooperation, climate and affordable energy for all Nordic and Baltic households and limit energy poverty.

Therefore, I sincerely hope that the statistical analyses in this short report will enlighten us, and that it will serve as a knowledge base for policy measures, to prevent energy poverty and ensure stronger cooperation and affordable energy for all Nordic and Baltic households.

KLAUS SKYTTE, CEO, NORDIC ENERGY RESEARCH

Disclaimer This report originally came out as a JRC Science for Policy Brief and is re-produced here as part of the EU Commission’s re-use policy. The opinions expressed in this publication are those of the author. They do not necessarily reflect the views of Nordic Energy Research or any entities it represents. “Inflation and its Social Consequences in the Nordic and Baltic Countries” by Balint Menyhert, (c) European Union, 2023, CC BY 4.0 licence https://creativecommons.org/licenses/by/4.0/”.

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Highlights → Over the 2021-2022 period, consumer prices have increased by 10 – 30% in the Nordic and Baltic countries. → Current inflation is driven by food and energy prices, and the structure of consumption expenditures plays a crucial role in determining households’ vulnerability. → Higher and more uneven spending on essential items creates higher inflation inequality and living cost adjustments in the Baltic countries relative to the Nordiccountries. → The social consequences of inflation are substantial, largely uneven, and likely to widen existing inequalities across Northern Europe. The potential effects on poverty, material deprivation and energy insecurity are particularly alarming in the Baltic countries, and call for an effective policy response.

rising prices are offset by effective policies, inequalities and social distress are bound to increase across the EU. Based on previous JRC analysis [8], this Science for Policy Brief provides a cursory analysis of the most salient developments in Northern Europe – including Iceland and Norway as non-EU countries. The Nordic and Baltic states merit particular attention on account of their peculiar geopolitical position, distinctive socio-economic structures and institutional arrangements. Despite their common climate and shared commitment to environmental sustainability, social cohesion and digitalisation, the Nordic and Baltic countries also display large differences in terms of the level of economic development, the structure of household consumption, and the extent and nature of social inequalities. These factors have been important drivers of inflation trends and its social consequences, and have produced markedly different socioeconomic outcomes across the EU [2] [8]. The current Brief attempts to illuminate these linkages in the context of Northern Europe, quantify the impact of rising prices on households’ living conditions, and highlight some of the related social policy challenges.

Differences in inflation profiles As elsewhere in the EU, Nordic and Baltic countries have experienced steeply increasing consumer prices from early 2021 onwards. Recent Eurostat figures indicate that, as of December 2022, headline annual HICP inflation in Northern Europe has reached 12.6% on average (vs. 10.4% at the EU level), driven mainly by energy prices (27.6%) and food prices (17.1%).

Consumer prices have increased by more than 20% on average across the region over the 2021-2022 period, and further increases are predicted for 2023 [4].

Figure 1 – Consumer price inflation by component in 2021-2022

Introduction and policy context After decades of price stability, rising inflation presents new economic, political and social challenges everywhere. According to Eurostat figures, consumer prices have increased by more than 16% in the EU over the 2021-2022 period. Inflation has been fuelled mainly by surging energy prices (57.6% increase over the same period), with rising food prices (19.8% increase) further aggravating the situation in most Member States. This has eroded the purchasing power of many households and given rise to financial distress, poverty and social exclusion. Unless the social consequences of 4

The presented findings are preliminary and subject to various limiting assumptions. First, they rely on a snapshot of observedprice developments as of December 2022, and are liable to changes as inflation trends and profiles keep evolving over time. Second, they are subject to various simplifying assumptions regarding inflation heterogeneity within countries, households’ consumption structure and contemporaneous income developments [8]. These limit one’s ability to accurately describe ongoing social developments, but offer a useful modelling framework for predictive scenario analysis.

Notes: Own calculations based on the combination of previous data (as of December 2021) and recent data (as of December 2022) on annual HICP inflation by country and main consumption by purpose (COICOP) category by Eurostat (series pcr_hicp_manr).

From a social perspective, the structure of inflation profiles are just as relevant as the inflation rate itself.

While the broad inflationary pressures are similar across Northern Europe, national differences in market conditions, household consumption, resource utilisation and the regulatory environment imply rather uneven consumer price trends across the Nordic and Baltic countries. Figure 1 presents the main inflation patterns over the entire 2021-2022 period, and shows that national HICP rates varied between 11.4% (in Iceland) and 32.8% (in Lithuania). Overall inflation has been considerably lower in the Nordic countries (13.1% on average vs. 31.6% in the Baltics), due to systematically lower price increases in all main product categories (i.e. food, energy, non-energy goods, services) – with the possible exception of high energy inflation in Norway and high services inflation in Iceland. Interestingly, within-country correlations in price trends between various product categories are rather small, suggesting that the pass-through of the energy price hikes to other product categories and core inflation has remained contained so far.

A comprehensive analysis of all drivers of the cross-country dispersion of inflation profiles is beyond the scope of this analysis. The current Brief focuses only on the most important factor that explains more than two-thirds of the total statistical variability in headline inflation rates across Northern Europe: households’ expenditure structure. It appears that the Baltic states were to face substantially higher inflation and socio-economic challenges than Nordic countries even in the presence of fully identical monetary shocks.

Variations in household consumption

Figure 2 – Main patterns of household consumption by country

To analyse the societal costs of inflation, it is therefore important to consider households’ consumption structure. Since current price trends are driven mainly by soaring food and energy prices, financially constrained households that spend a higher share of their income on essential items (and have less elastic consumer demand) are at a disadvantage. This inequality aspect of inflation traditionally received little scholarly attention, but efforts to measure the gap between the perceived inflation rates among lowincome and high-income households have multiplied recently [2] [3] [8] [11].

The detailed analysis of European households’ expenditure patterns can help better understand this phenomenon. Using microdata from the latest available 2015 wave of the EU Household Budget Survey (EU-HBS) allows one to differentiate consumer spending between main product categories (such as food, energy, non-energy industrial goods and services), and compare the consumption structure of low-income and high-income households between and within countries [5] [8] [11].

Figure 2 shows households’ main expenditure patterns across Northern Europe. It reveals that Nordic and Baltic countries are characterised by very different consumption profiles: on average, Baltic households spend almost twice as high a share of their total budget on food and energy than Nordic households (53.5% vs. 28%). Much of this divergence stems from differences in the level of household income between the two country groups, and is the direct result of Engel’s law.

Notes: Own analysis of microdata from the 2015 wave of the EU-HBS. The bars represent the average share of food and energy expenditures in households’ total consumption by country. The markers denote the difference in the combined food and energy expenditure share across households of the first (Q1) and fifth (Q5) income quintiles in each country. Data for Iceland and Norway are based on aggregate figures by Eurostat [series HBS_STR_T211 and HBS_STR_T223], and not fully appropriate or available.

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Furthermore, Figure 2 also shows that households’ food and energy expenditures vary equally within countries: the gaps in the relevant expenditure shares between the lowest (Q1) and highest (Q5) income quintiles amount to 0-5 p.p. in the Nordic countries and 18-20 p.p. in the Baltic countries. This large disparity is explained partly by the generally higher income elasticity of essential (food and energy) spending among lowerincome households, and partly by higher income inequality and relative poverty in Baltic societies.1 Therefore, while lowincome households have been exposed disproportionately more to recent inflationary pressures throughout Northern Europe (with the possible exception of Iceland and Sweden), they have found themselves in a particularly precarious position in the Baltic states.

Another noteworthy aspect of national consumption patterns is the large variability across households with similar socio-economic background. The analysis of EU-HBS microdata reveals that, within any given income quintile of the national population, the combined food and energy expenditure share may fluctuate by up to 40 percentage points for a typical household. This means that many citizens are more dependent on essential items than what aggregate statistics suggest. This is the case in particular in the Baltic countries where socio-economic gaps between

urban-rural populations and different household types are more pronounced. Additional data collection and harmonisation on households’ living conditions could help explain the unobserved heterogeneity in consumption patterns, identify the relevant vulnerability factors, and better assess the true financial and societal risks associated with inflation or economic distress.

In light of soaring energy prices, the energy mix constitutes a further important dimension of households’ consumption. Figure 3 shows the typical structure of households’ energy spending by country and energy source, and highlights the importance of electricity for housing-related use and gasoline for transportationrelated use throughout Northern Europe. It also shows that widespread reliance on other, less conventional energy sources (such as district, geothermal or solar heating) is limited to Denmark and the Baltic states. Since the price levels and price trends associated with these various components tend to be rather divergent, households’ energy mix represents an additional channel where inflation developments and consumption patterns strongly interconnect.

Figure 3 – Structure of households´energy consumption by country

Notes: Own analysis of microdata from the 2015 wave of the EU-HBS. The bars represent the average share of energy expenditures in households’ total consumption by country, broken down by energy source according to the standard (5-digit) COICOP classification. Data for Iceland and Norway are based on aggregate figures by Eurostat [series HBS_STR_T211 and HBS_STR_T223].

The at-risk-of-poverty (AROP) rate in 2021 was 9-16% in the Nordic countries and 20-23% in the Baltic countries, according to the latest Eurostat data. See detailed statistics here.

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Figure 4 – The change in households´living cost by components

Implications for the cost of living Combining the inflation profiles with the structure of household expenditures, one can calculate the change in households’ living costs and purchasing power in a customised manner.2 Consequently, households that spend a higher fraction of their budget on product categories with relatively high inflation will see a larger increase in their cost of living and bigger losses in their purchasing power. This procedure is the standard approach to analysing the distributional aspects of inflation [6] [8].3

Notes: Own calculations based on annual HICP inflation data from Eurostat and microdata from the 2015 wave of the EU-HBS. The bars represent the implied overall change in households’ living costs over the 2021-2022 period. The markers represent the percentage point difference in total living cost adjustments between the 1st and 5th income quintiles. The relevant calculations for Iceland and Norway are based on aggregate expenditure data by Eurostat, and not complete due to missing information.

Figure 4 shows that the resulting change in living costs during the 2021-2022 period varies between 11.7% (in Iceland and Finland) and 40.6% (in Lithuania) across Northern Europe – broadly in line with the respective headline inflation rates. The figure also reveals that food and energy expenditures are the main drivers of the rise in living costs (33.3% and 32.3% on average), whereas the relative contribution of goods and services remains limited in most countries (except for Iceland).

Importantly, Figure 4 also shows the difference in the cost of living adjustments between low-income and high-income households in a country, due to their divergent consumption structures. Given the typically higher share of spending devoted to food and energy among low-income households, the gaps in living cost adjustments between the lowest and highest income

quintiles is somewhat positive. It amounts to 3-6 percentage points in the Baltic countries, but remains below 1 percentage point in the Nordic countries due to households’ homogenous consumption patterns.4 The strong positive correlation between the average level of living cost adjustment and Q1/Q5 gap across countries suggests that low-income segments of the Baltic population are particularly exposed to the negative effects of inflation.

The social consequences of inflation All else being equal, increases in households’ living costs translate into commensurate losses in purchasing power and real disposable income.

Quantifying the effects of inflation on key indicators of poverty and social exclusion is nevertheless far from straightforward. Part of the reason lies with data lags and limitations surrounding European household surveys on income and consumption, but equally important is the fact that many leading EU social policy indicators are either non-monetary or only indirectly affected by changes in the cost of living.

This section discusses the partial effects of inflation on some of those indicators of poverty and social exclusion that are responsive to changes in households’ purchasing power – without considering the potential simultaneous effects of income support measures, demand substitution, or other behavioural changes and interventions.

In practice, this means taking the weighted-average of each main inflation component by product category, whereby the relevant expenditure shares of target households are used as weights.

The two underlying assumptions are that headline HICP inflation adequately captures the change in consumer prices for all population segments, and that substitution effects are negligible and households retain their consumption structure even in the face of changing relative prices. For a detailed discussion, see [6] and [8].

4 The negative case of inflation inequality in Sweden is due mainly to high-income households comparatively high energy expenditure share (11.2% in Q5) relative to that of low-income households (8.0% in Q1).

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Figure 5 – The effect of inflation on material and social deprivation

Figure 6 – The effect of inflation on absolute monetary poverty

Notes: Own analysis of microdata from the 2019 wave of the EU-SILC. The bars represent the pre-existing level and predicted change over 2021-2022 in the MSD rate, as calculated from the change in households’ living cost adjustments and estimated real income elasticities.

Notes: Analysis of microdata from the 2019 wave of the EU-SILC. The bars represent the pre-existing level and predicted change over 2021-2022 in the ABSPO absolute poverty rate, as calculated on the basis of households’ living cost adjustments. Iceland and Norway are missing due to data limitations.

The first such indicator is the so-called material and social deprivation (MSD) rate based on the EU Statistics on Income and Living Conditions (EU-SILC).

The MSD rate indicates households’ inability to afford certain necessary or desirable items needed for an adequate standard of living. As a composite non-monetary indicator across 13 sub-categories, it records the share of the population experiencing deprivation in at least five areas. To capture the inflation effects on MSD, one may employ a regression-based method that focuses on the income elasticity of individuals’ deprivation status using historical crosssectional comparisons from the pre-Covid and pre-inflation period [8]. Scaling up the estimated income elasticities by the observed living cost adjustment in a country yields the predicted increase in the deprivation rate. Figure 5 shows that this amounts to less than 2 p.p. in the Nordic countries and above 10 p.p. in the Baltic states – reflecting large differences in both pre-existing deprivation patterns and the size of the living cost adjustments. The figures suggest that recent inflationary pressures have been widening social inequalities across Northern Europe.

The second topical measure is that of absolute monetary poverty. In this regard, one may rely on a set of cross-country comparable absolute poverty thresholds produced by a recent JRC initiative (“Measuring and monitoring of absolute poverty ABSPO”) for all EU countries [9]. Since the relevant ABSPO poverty lines are explicitly designed to reflect households’ basic needs and minimum living costs, they can be easily adjusted to capture real or hypothetical changes in households’ financial position and social situation [8]. Figure 6 shows the pre-existing

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Figure 7 – The effect of inflation on energy poverty

Notes: Analysis of microdata from the 2019 wave of the EU-SILC based on Menyhért (2022). The bars represent the pre-existing level and predicted change in expenditure-based energy poverty over 2021-2022, using 30% of households’ total expenditure as the poverty threshold. Iceland and Norway are missing due to data limitations.

level and predicted change due to inflation in absolute poverty for EU Member States of the region. It reveals that absolute poverty may have potentially increased by 11.9 p.p. during the 2021-2022 period on average.

As with most other social measures, the relevant country-specific figures are much higher in the Baltic states (18.7 p.p.) than in the Nordic countries (5.2 p.p.), and reflect large differences in the national population shares with financial resources only marginally above the preexisting ABSPO thresholds.

Importantly, close to half of all Latvian and Lithuanian citizens, and more than 1 million additional persons across Northern Europe, may now be at risk of failing to attain the minimum standards for a decent living.

It is also possible to quantify the effects of rising energy costs and consumer prices on measures of energy poverty. The latter is defined as a situation in which households are unable to access essential energy services, and is measured in a variety of ways.

One set of energy poverty indicators focuses on individuals’ selfreported inability to keep one’s home adequately warm or pay utility bills without arrears.

Other indicators focus directly on households’ energy expenditures, and calculate the corresponding change as a result of energy price inflation [7]. Figure 7 shows the share of population in Northern EU countries that may spend more than 30% of their budget on energy under the pre-inflation and post-inflation scenarios [8]. It reveals that rising energy prices during 2021 and 2022 may have increased certain forms of energy poverty by 3-7 p.p. in the Nordic countries and 23-34 p.p. in the Baltics. While the true change in energy poverty is expected to be smaller due to household savings and government support, these

findings indicate a very high vulnerability on the part of Baltic households to changes in energy prices.

Conclusions and policy recommendations The main conclusions of the above analysis are robust: the negative welfare and social effects of recent inflation are substantial and very unevenly spread across Northern Europe. On the one hand, the Baltic countries have experienced a 30% rise in their living costs, and up to one third of their population may be at potential risk of financial distress, material and social deprivation, or energy insecurity. At the same time, most Nordic households have seen relatively minor shifts to their living costs, risk of poverty, or social exclusion. It is nevertheless worth noting that, due to large within-country differences in consumption patterns, perceived inflation and living cost adjustments, substantial parts of population – especially rural communities, large households, children and the elderly – may find themselves in a precarious position in Baltic and Nordic countries alike.

Consequently, inflation appears set to have increased inequality and eroded social cohesion throughout Northern Europe.

This calls for a strong and extensive policy response.

One obvious area for intervention concerns short-term emergency measures aimed at offsetting some of the immediate consequences of price increases (such as VAT and excise duty reductions), and most Nordic and Baltic countries have already introduced such measures. Over the medium term, a key social policy challenge lies in strengthening the redistributive capacity of fiscal policy and ensuring the effectiveness of social protection systems. This primarily requires 9

targeted income policies and financial support that benefit the most vulnerable and ensure that essential goods and services are readily available to all [1]. The broader and long-term policy objective is to align protective measures with the strategic priorities regarding environmental sustainability, the green transition and energy efficiency [10].

References [1] Bethuyne, G., A. Cima, B. Döhring, Johannesson Lindén, A. Kasdorp, R. and J. Varga, “Targeted income support is the most social and climate-friendly measure for mitigating the impact of high energy prices”, VoxEU.org, 6 June 2022.

[2] Causa, O. E. Soldani, N. Luu and C. Soriolo, “A cost-of-living squeeze? Distributional implications of rising inflation”, OECD Economics Department Working Papers, No. 1744, 2022.

[3] Charalampakis, E., Fagandini, B., Henkel, L. and C. Osbat, “The impact of the recent rise in inflation on low-income households”, ECB Economic Bulletin, 07/2022.

[4] European Commission, “Winter 2023 Economic Forecast”, 2023.

[5] Eurostat, “Harmonised Index of Consumer Prices (HICP)”, 2018.

[6] Kaplan, G. and S. Schulhofer-Wohl, “Inflation at the household level”, Journal of Monetary Economics, Vol. 91., 2017.

[7] Koukoufikis G. and A. Uihlein, “Energy poverty, transport poverty and living conditions – An analysis of EU data and socioeconomic indicators”, European Commission, JRC128084, 2022.

[8] Menyhért, B., “The effect of rising energy and consumer prices on household finances, poverty and social exclusion in the EU”, EUR 31257 EN, European Commission, JRC130650, 2022.

[9] Menyhért, B., Zs. Cseres-Gergely, V. Kvedaras, B. Mina, F. Pericoli and S. Zec, “Measuring and monitoring absolute poverty (ABSPO) – Final Report”, JRC127444, 2021.

[10] Mikkonen, I., L. Gynther, K. Matschoss, G. Koukoufikis, I. Murauskaite, and A. Uihlein, “Social innovations for the energy transition”, EUR 30446 EN, European Commission, JRC122289, 2020.

[11] Villani, D. and G. Vidal Lorda, “Whom does inflation hurt most?”, European Commission, JRC129558, 2022.

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Contact information Balint.Menyhert@ec.europa.eu Acknowledgments The author would like to thank Federico Biagi, Karolina Gralek and two anonymous referees for their valuable comments and suggestions.

Disclaimer or other final details This policy brief has been prepared by Balint Menyhert, JRC Unit B.1. The opinions expressed in it are those of the author and cannot be attributed to the European Commission or any of its Member State.

Copyright © European Union, 2023, except for cover image © Massimo Rinaldi / unsplash.com

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