Redistributive Effects of a Change in the Inflation Target

In light of the financial crisis and its aftermath, several economists have argued that inflation-targeting central banks should reconsider the level of their inflation targets. While the appropriate level for the inflation target remains an open question, it’s important to note that any transition to a new target would entail certain costs. In this note, we consider one dimension of these costs, namely, the redistributive effects stemming from the fact that financial contracts are often written in nominal terms and would thus experience changes in real value following the announcement of a new target. We use Canadian data on the distribution of nominal assets and liabilities to predict the redistribution of wealth that would occur following a permanent 1-percentage-point increase in the rate of inflation, both across sectors and between various demographic cohorts. We find that this change would trigger a large redistribution of wealth from the household sector to government, mainly through a reduction in the real value of government bonds and unindexed pensions. However, losses are unevenly distributed across the household sector, with a disproportionate share falling on middle-class and wealthier households. We also use a macro model to explore potential implications for output and find that these depend critically on the particular use to which the government directs its windfall.