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Scottish Joiirrial of Political Econorny, Vol. XXIII, No. 1, February 1976
THE REDISTRIBUTIVE EFFECTS OF
I N F L A T 1 0 N-Q U E S T I 0 N S A N D
ANSWERS*
JOHN FOSTER
I
INTRODUCTION
The study of inflation can be divided into three basic areas of interest:
namely, cause, cures and consequences. Historically, most economic research
has been concentrated in the first two areas, the third receiving relatively
little attention from economists. This neglect is surprising in view of the
fact that the stimulus for research into the causes and the search for cures
is derived from popular feelings that inflation has adverse consequences.
In particular, there is a widespread view that inflation acts as a redistributor
of income and wealth. However, this popular view is rarely based on a
recognised body of economic literature but rather on the ad hoc assessments
of politicians, journalists and other representatives of various groups in
society.
The objectives of this paper are twofold. First, an analytical framework
is developed in order to classify important questions concerning the redistri-
butive effects of inflation. Second, this framework is utilised to review the
existing disparate strands of economic evidence in a systematic way and
to indicate what important questions remain unanswered.
I1
ANALYTICAL
FRAMEWORK
At the outset, the distinction between vulnerability to inflationary
depreciation and redistribution must be made. This distinction is frequently
neglected, assumed away or confused in the literature and therefore deserves
to be spelt out.
Inflation has two depreciating effects that an asset may be exposed to.
First, there is the capital effect. Any asset which is priced or valued in money
terms will depreciate in real terms through inflation. Second, there is the
income effect. Any asset which yields a money income stream will have
that flow reduced in real terms by inflation. Whether or not any asset is
vulnerable to these depreciating effects will depend on the basic nature of
the asset and its yield. Some assets and yields are inherently excluded from
* I am indebted to David Laidler for his continued advice and encouragement and
to all members of the Manchester Inflation Workshop for their discussion and
comments on an early draft of this paper. All shortcomings remain the author’s
responsibility.
,74 zyxwvutsrqpo
zyxwvutsrq
zyxwvu JOHN FOSTER
explicit money valuation simply because they are inalienable by nature
(e.g. leisure) or by law (e.g. human capital since the abolition of slavery).
All assets can be classified in the following categories :
Table I
AN ASSETCLASSIFICATION
BY INFLATION
VULNERABILITY
Nature of capital valuation Nature of income valuation
-____
Monetary Monetary
Monetary Non-monetary
Non-monetary Monetary
Non-monetary Non-monetary
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Assets classified in Category 1 are most vulnerable and those in Category
4 least vulnerable with total immunity against inflationary depreciation.
Since income yield in any period is generally less than the value of the
asset, Category 2 assets tend to be more vulnerable than those in Category 3.
However, irrespective of the vulnerability classification of an asset,
inflationary depreciation will only result in redistribution if it has not been
accurately accounted for either through an alteration in the nominal valua-
tion of the asset and/or through an upgrading of the nominal interest income
yielded by the asset. Thus the incidence of inflationary depreciation is a
necessary but not sufficient condition for redistribution to occur.
Compensation for inflationary depreciation involves two fundamental
questions. First, what is the process, if any, whereby compensation can
occur? Second, what determines the extent of this compensation if it occurs
at all? Let us deal with each question in turn.
1. Ojgsetting Processes
In order to classify assets in terms of the compensation method available,
the four category vulnerability classification requires expansion. If each
monetary valuation is either nominally fixed or variable, there are nine
possible combinations in the 'variability' classification. Category 1 expands
into four combinations. Category 2 only expands into two combinations
since only capital is monetarily valued and of these two possibilities only
one is relevant, namely, the variable nominal capital case. This is so because
monetarily valued assets yielding non-monetary income are exclusively physi-
cal assets yielding a flow of services. Such assets are by their nature variable
in nominal capital valuation. Similarly, Category 3 only expands into two
combinations since only income is monetarily valued. Again, only one asset
is relevant, namely, the variable nominal income case. This is so because
only one kind of asset has a non-monetary capital valuation, namely, human
capital. Category 3 embraces the case where an individual hires out his
human capital to an employer for a return which is principally financial
Some assets can be classified in more than one category. For example, an asset
with a money price may yield a combination of monetary and non-monetary income.
, zyxw
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R E D I S T R I B U T I V E E F F E C T S OF INFLATION
income and inherently variable. Category 4 includes only the case of an
individual utilising his human capital to yield personal services, such as
leisure, and, of course, both capital and income are completely inflation-
proof.
75
Table I1
A CLASSIFICATION OF ASSETSBY METHODOF COMPENSATION
FOR INFLATIONARY DEPRECIATION
Vulnerability Variability Compensatior Marketability Asset
category Capital Income method (M) group
Fixed nom. Fixed nom. None Non-M Money
Fixed nom. Var. nom. Income gain Non-M Claims
Var. nom. Fixed nom. Capital loss M Bonds
Var. nom. Var. nom. Capital and M Equities
income gain
Var. nom. Fixed real Capital gain M Physicals
Fixed real Var. nom. Income gain Non-M Employment
Fixed real Fixed real Inflation Non-M Leisure
proof
In Table I1 the seven variability categories are set out. For each category
we can identify the appropriate compensation method. Those with variable
nominal capital valuation, involving capital adjustments, will be marketable
assets and those with fixed nominal capital valuations will be non-marketable
a s s e t ~ .This
~ seven category classification is completely comprehensive
embracing all the principal types of asset. In the last column of Table I1
the hitherto anonymous assets are identified.
The only asset type that offers no scope for compensation for inflationary
depreciation is, of course, money.&At the other end of the spectrum the
only asset that is completely inflationproof is leisure. This leaves five
intermediate asset types that offer scope for compensation. It is interesting
zyxwvutsr
to note the symmetrical nature of this classification with three central
marketable assets bounded by two distinct types of claim-on one side the
financial one and on the other the human capital one. In an inflationary
context the two extreme assets, money and leisure, are certainly very different
but their polar positions are misleading for in many respects they are very
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similar assets.
2 In the ensuing discussion ‘money’ is used to mean ‘non-interest bearing money’
and ‘leisure’ to mean ’human capital devoted to leisure activities’.
Assets are defined here as marketable or non-marketable according to their
ability to offer scope for compensation for inflation through market price adjustment.
Thus we have highly liquid money classified as a non-marketable asset in these terms
since it is the unit of account, offering no scope for compensation through market
adjustment in money terms.
4 J t is, perhaps, worthwhile spelling out why the income yielded by money is
fixed in nominal terms. This is because the real flow of money services depends on
the size of real money balances. Therefore just as the real value of money balances
declines by the rate of inflation, the real services yielded by the money balances will
also decline by the rate of inflation, in exactly the same way as would a stream of
income fixed in nominal terms.
zyxwvutsrq
zyxwvutsrqp
Scottish Joiirrial of Political Econorny, Vol. XXIII, No. 1, February 1976
THE REDISTRIBUTIVE EFFECTS OF
I N F L A T 1 0 N-Q U E S T I 0 N S A N D
ANSWERS*
JOHN FOSTER
I
INTRODUCTION
The study of inflation can be divided into three basic areas of interest:
namely, cause, cures and consequences. Historically, most economic research
has been concentrated in the first two areas, the third receiving relatively
little attention from economists. This neglect is surprising in view of the
fact that the stimulus for research into the causes and the search for cures
is derived from popular feelings that inflation has adverse consequences.
In particular, there is a widespread view that inflation acts as a redistributor
of income and wealth. However, this popular view is rarely based on a
recognised body of economic literature but rather on the ad hoc assessments
of politicians, journalists and other representatives of various groups in
society.
The objectives of this paper are twofold. First, an analytical framework
is developed in order to classify important questions concerning the redistri-
butive effects of inflation. Second, this framework is utilised to review the
existing disparate strands of economic evidence in a systematic way and
to indicate what important questions remain unanswered.
I1
ANALYTICAL
FRAMEWORK
At the outset, the distinction between vulnerability to inflationary
depreciation and redistribution must be made. This distinction is frequently
neglected, assumed away or confused in the literature and therefore deserves
to be spelt out.
Inflation has two depreciating effects that an asset may be exposed to.
First, there is the capital effect. Any asset which is priced or valued in money
terms will depreciate in real terms through inflation. Second, there is the
income effect. Any asset which yields a money income stream will have
that flow reduced in real terms by inflation. Whether or not any asset is
vulnerable to these depreciating effects will depend on the basic nature of
the asset and its yield. Some assets and yields are inherently excluded from
* I am indebted to David Laidler for his continued advice and encouragement and
to all members of the Manchester Inflation Workshop for their discussion and
comments on an early draft of this paper. All shortcomings remain the author’s
responsibility.
,74 zyxwvutsrqpo
zyxwvutsrq
zyxwvu JOHN FOSTER
explicit money valuation simply because they are inalienable by nature
(e.g. leisure) or by law (e.g. human capital since the abolition of slavery).
All assets can be classified in the following categories :
Table I
AN ASSETCLASSIFICATION
BY INFLATION
VULNERABILITY
Nature of capital valuation Nature of income valuation
-____
Monetary Monetary
Monetary Non-monetary
Non-monetary Monetary
Non-monetary Non-monetary
zyxwvuts
Assets classified in Category 1 are most vulnerable and those in Category
4 least vulnerable with total immunity against inflationary depreciation.
Since income yield in any period is generally less than the value of the
asset, Category 2 assets tend to be more vulnerable than those in Category 3.
However, irrespective of the vulnerability classification of an asset,
inflationary depreciation will only result in redistribution if it has not been
accurately accounted for either through an alteration in the nominal valua-
tion of the asset and/or through an upgrading of the nominal interest income
yielded by the asset. Thus the incidence of inflationary depreciation is a
necessary but not sufficient condition for redistribution to occur.
Compensation for inflationary depreciation involves two fundamental
questions. First, what is the process, if any, whereby compensation can
occur? Second, what determines the extent of this compensation if it occurs
at all? Let us deal with each question in turn.
1. Ojgsetting Processes
In order to classify assets in terms of the compensation method available,
the four category vulnerability classification requires expansion. If each
monetary valuation is either nominally fixed or variable, there are nine
possible combinations in the 'variability' classification. Category 1 expands
into four combinations. Category 2 only expands into two combinations
since only capital is monetarily valued and of these two possibilities only
one is relevant, namely, the variable nominal capital case. This is so because
monetarily valued assets yielding non-monetary income are exclusively physi-
cal assets yielding a flow of services. Such assets are by their nature variable
in nominal capital valuation. Similarly, Category 3 only expands into two
combinations since only income is monetarily valued. Again, only one asset
is relevant, namely, the variable nominal income case. This is so because
only one kind of asset has a non-monetary capital valuation, namely, human
capital. Category 3 embraces the case where an individual hires out his
human capital to an employer for a return which is principally financial
Some assets can be classified in more than one category. For example, an asset
with a money price may yield a combination of monetary and non-monetary income.
, zyxw
zyxwvu
R E D I S T R I B U T I V E E F F E C T S OF INFLATION
income and inherently variable. Category 4 includes only the case of an
individual utilising his human capital to yield personal services, such as
leisure, and, of course, both capital and income are completely inflation-
proof.
75
Table I1
A CLASSIFICATION OF ASSETSBY METHODOF COMPENSATION
FOR INFLATIONARY DEPRECIATION
Vulnerability Variability Compensatior Marketability Asset
category Capital Income method (M) group
Fixed nom. Fixed nom. None Non-M Money
Fixed nom. Var. nom. Income gain Non-M Claims
Var. nom. Fixed nom. Capital loss M Bonds
Var. nom. Var. nom. Capital and M Equities
income gain
Var. nom. Fixed real Capital gain M Physicals
Fixed real Var. nom. Income gain Non-M Employment
Fixed real Fixed real Inflation Non-M Leisure
proof
In Table I1 the seven variability categories are set out. For each category
we can identify the appropriate compensation method. Those with variable
nominal capital valuation, involving capital adjustments, will be marketable
assets and those with fixed nominal capital valuations will be non-marketable
a s s e t ~ .This
~ seven category classification is completely comprehensive
embracing all the principal types of asset. In the last column of Table I1
the hitherto anonymous assets are identified.
The only asset type that offers no scope for compensation for inflationary
depreciation is, of course, money.&At the other end of the spectrum the
only asset that is completely inflationproof is leisure. This leaves five
intermediate asset types that offer scope for compensation. It is interesting
zyxwvutsr
to note the symmetrical nature of this classification with three central
marketable assets bounded by two distinct types of claim-on one side the
financial one and on the other the human capital one. In an inflationary
context the two extreme assets, money and leisure, are certainly very different
but their polar positions are misleading for in many respects they are very
zyxwvutsrqponmlkji
similar assets.
2 In the ensuing discussion ‘money’ is used to mean ‘non-interest bearing money’
and ‘leisure’ to mean ’human capital devoted to leisure activities’.
Assets are defined here as marketable or non-marketable according to their
ability to offer scope for compensation for inflation through market price adjustment.
Thus we have highly liquid money classified as a non-marketable asset in these terms
since it is the unit of account, offering no scope for compensation through market
adjustment in money terms.
4 J t is, perhaps, worthwhile spelling out why the income yielded by money is
fixed in nominal terms. This is because the real flow of money services depends on
the size of real money balances. Therefore just as the real value of money balances
declines by the rate of inflation, the real services yielded by the money balances will
also decline by the rate of inflation, in exactly the same way as would a stream of
income fixed in nominal terms.
