Explain likely impact on income distribution of inflation falling “below the 2% target” (Extract 3, lines 5–6).

If Inflation rate slows down from +2% to +1% then effect on income distribution widens (2) as real value of savings and borrowings eroded at a slower rate (2) so higher income households will find their savings have higher purchasing power in the future whereas low income households will not find inflation eroding the real value of the money they owe.


If  the UK experiences a sustained period of deflation then inequality may widen further. When households borrow money "we expect inflation to rescue us from our debt" (Marryn Somerset Webb, FT - Deflation isn't such a bonus afterall). The house your parents bought for £90,000 may today be worth £400,000 after two decades of inflation. £90,000 debt seemed very large to them initially - now imagine yourself buying a house for £500,000 and the economy experiencing two decades of deflation.

Lower inflation may though mean lower interest rates resulting in a narrowing of inequality -see earlier posting.

Lower inflation may also mean less fiscal drag as tax bands do not rise with inflation so tax revenue does not rise without the state raising tax rates. The Government might need to make benefit cuts or increase tax on high income erarners so impact on inequality is exogenous here.