The Impact of Relative Prices on Welfare and Inequality in Brazil, 1995-2005

Abstract

Our objective in this working paper is to analyze the impact of relative prices on the evolution of welfare and inequality in Brazil from 1995 to 2005. This period was characterized by monetary stability but also by large changes in relative prices. This implies that a homogeneous inflation index will yield questionable results. In order to take relative prices into account in our welfare analysis, we build specific inflation indices for each hundredth of the population ranked by per capita household income. To accomplish this task, we use data from the latest round of the Brazilian income and expenditure survey and price indices obtained from the national consumer price system. We use our distribution-specific inflation indices to deflate the nominal income distributions yielded by the Brazilian annual household survey from 1995 to 2005. Thus, we generate new income distributions that better represent the real purchasing power of the households. Based on these new income distributions, we calculate average incomes and Gini coefficients, investigate the relationships of stochastic dominance as well as Lorenz dominance, and calculate Atkinson’s social welfare function for inequality aversion parameters varying from 0.1 to 0.9. Our results can be summarized into three stylized facts: i) inflation during the 1995-2005 period was distributionally progressive up to the 93rd hundredth of the per capita household income distribution; ii) taking relative prices into account, the Gini coefficient falls 0.61 points (or 19 per cent) more than when a general price index is used; iii) surprisingly, average income deflated by the distribution-specific indices differs significantly from average income deflated by the general price index, i.e., it falls instead of rising slightly from 1995 to 2005.