Permanent income shocks and inflation

A puzzle in the literature on the macroeconomic effects of permanent income shocks is that exogenous permanent Social Security shocks do not have a sustained positive effect on real aggregate consumption. It has been argued that this is due to the implementation of contractionary monetary policy in wake of these benefit increases. This paper documents an alternative, potentially complementary explanation for the puzzle. Namely, using exogenous permanent Social Security shocks as well as minimum wage increases, I show that these permanent income shocks lead to an increase in inflation in less than twelve months. Thus while nominal aggregate consumption gains can be observed in the data, real gains are small to non-existent due to the higher price level.