European Central Bank working paper finds a 1% demand shift toward low-quality goods raises their relative prices by about 0.45%

The European Central Bank published a working paper by Mar Domenech Palacios analysing how households adjust the quality of their purchases after adverse economic shocks and how this “heterogeneous trading down” shapes inflation risk across income groups. Using German supermarket scanner data, the paper finds that higher-income households tend to trade down to cheaper varieties during downturns, while many lower-income households have limited scope to do so, contributing to inflation inequality. Drawing on a household panel covering 2005–2018, the study estimates that around 10–20% of households are at a “quality lower bound” because they already purchase the lowest-quality goods. To quantify the equilibrium price effects of a recession-driven shift in demand toward lower-quality varieties, it applies a shift-share design combining pre-crisis spending shares on middle-quality varieties with demographic population changes during the great financial crisis. The results suggest that a 1% aggregate demand shift toward lower-quality varieties raises the relative price of low-quality goods by about 0.45% on average and by as much as 1.9% relative to high-quality varieties, implying that households least able to substitute can face both constrained adjustment and higher relative prices for the goods they already consume.