The Distributional Impact of Inflation in Pakistan: A Case Study of a New Price Focused Microsimulation Framework, PRICES

TL;DR

This paper introduces a new microsimulation framework, PRICES, to analyze how recent inflation in Pakistan affects household welfare distribution, revealing that food inflation significantly impacts the poor while overall welfare losses are mildly progressive.

Contribution

The paper develops a novel price-focused microsimulation model, PRICES, and demonstrates its application in assessing the distributional and welfare impacts of inflation in Pakistan.

Findings

Welfare losses are significant across all income groups due to inflation.

Food price inflation is the main driver of welfare loss at the lower end of the income distribution.

Household transfers of around 40% of pre-inflation expenditure could offset increased living costs.

Abstract

This paper develops a microsimulation model to simulate the distributional impact of price changes using Household Budget Survey data, income survey data and an Input Output Model. The primary purpose is to describe the model components. The secondary purpose is to demonstrate one component of the model by assessing the distributional and welfare impact of recent price changes in Pakistan. Over the period of November 2020 to November 2022, headline inflation 41.5 percent, with food and transportation prices increasing most. The analysis shows that despite large increases in energy prices, the importance of energy prices for the welfare losses due to inflation is limited because energy budget shares are small and inflation is relatively low. The overall distributional impact of recent price changes is mildly progressive, but household welfare is impacted significantly irrespective of households position along the income distribution. The biggest driver of welfare losses at the bottom of the income distribution was food price inflation, while inflation in other goods and services was the biggest driver at the top. To compensate households for increased living costs, transfers would need to be on average 40 percent of pre-inflation expenditure, assuming constant incomes. Behavioural responses to price changes have a negligible impact on the overall welfare cost to households.