The cushioning effect of the measures adopted in Romania in response to the 2022 cost of living crisis

Amores, Antonio F. et al. Working Paper The cushioning effect of the measures adopted in Romania in response to the 2022 cost of living crisis JRC Working Papers on Taxation and Structural Reforms, No. 06/2024 Provided in Cooperation with: Joint Research Centre (JRC), European Commission Suggested Citation: Amores, Antonio F. et al. (2024) : The cushioning effect of the measures adopted in Romania in response to the 2022 cost of living crisis, JRC Working Papers on Taxation and Structural Reforms, No. 06/2024, European Commission, Joint Research Centre (JRC), Seville This Version is available at: https://hdl.handle.net/10419/311130 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Amores, A.F., Balaban, G., De Poli, S., Gavril, I., Leventi, C., Nae, T., Ricci, M. 2024 JRC Working Papers on Taxation and Structural Reforms No 06/2023 The cushioning effect of the measures adopted in Romania in response to the 2022 cost of living crisis JRC138324 Seville: European Commission, 2024 © European Union, 2024 The reuse policy of the European Commission documents is implemented by the Commission Decision 2011/833/EU of 12 December 2011 on the reuse of Commission documents (OJ L 330, 14.12.2011, p. 39). Unless otherwise noted, the reuse of this document is authorised under the Creative Commons Attribution 4.0 International (CC BY 4.0) licence (https://creativecommons.org/licenses/by/4.0/). This means that reuse is allowed provided appropriate credit is given and any changes are indicated. For any use or reproduction of photos or other material that is not owned by the European Union permission must be sought directly from the copyright holders. How to cite this report: European Commission, Joint Research Centre, Amores, A.F., Balaban, G., De Poli, S., Gavril, I., Leventi, C., Nae, T. and Ricci, M., The cushioning effect of the measures adopted in Romania in response to the 2022 cost of living crisis, European Commission, Seville, 2024, JRC138324. Contact information Name: Antonio F. AMORES Address: calle Inca Garcilaso, Ed. EXPO, 410952 Seville, SPAIN Email: [email protected] Tel.: +34 854 59 02 41 EU Science Hub https://joint-research-centre.ec.europa.eu This document is a publication by the Joint Research Centre (JRC), the European Commission’s science and knowledge service. It aims to provide evidence-based scientific support to the European policymaking process. The contents of this publication do not necessarily reflect the position or opinion of the European Commission. Neither the European Commission nor any person acting on behalf of the Commission is responsible for the use that might be made of this publication. For information on the methodology and quality underlying the data used in this publication for which the source is neither Eurostat nor other Commission services, users should contact the referenced source. The designations employed and the presentation of material on the maps do not imply the expression of any opinion whatsoever on the part of the European Union concerning the legal status of any country, territory, city or area or of its authorities, or concerning the delimitation of its frontiers or boundaries. 1 Contents Abstract ...................................................................................................................................................................................................... 2 Acknowledgements .............................................................................................................................................................................. 2 Executive summary .............................................................................................................................................................................. 3 1 Introduction ....................................................................................................................................................................................... 5 2 State of play and policy responses in Romania............................................................................................................ 8 3 Data and methodology ............................................................................................................................................................ 11 3.1 The microsimulation model ........................................................................................................................................ 11 3.2 Scenarios ............................................................................................................................................................................... 12 4 Results ............................................................................................................................................................................................... 13 4.1 The impact of the inflationary shock in Romania .......................................................................................... 13 4.2 The cushioning effect of policy measures ......................................................................................................... 16 4.3 Automatic versus discretionary policy .................................................................................................................. 18 5 Conclusions ..................................................................................................................................................................................... 21 References ............................................................................................................................................................................................. 22 List of figures ....................................................................................................................................................................................... 24 List of tables ......................................................................................................................................................................................... 24 2 Abstract In response to the energy crisis, which led to high inflation, Romania, like other EU Member States, introduced a series of price-related and income-related measures to cushion the negative impact on households’ welfare. Using EUROMOD and its Indirect Tax Tool extension, we assess the impact of these measures on welfare across the income distribution, while distinguishing between automatic stabilisers and discretionary measures. We find that these measures did not succeed in diminishing entirely the negative effect of the inflationary shock on the lowest-income population, given that, on the one hand, the shock was higher for low-income deciles, and, on the other hand, the policies applied were not sufficiently targeted. Against this background, the use of targeted measures is warranted in order to improve the welfare effect of such measures on lower-income households and diminish income inequalities resulting from the energy crisis. Acknowledgements We are indebted to Salvador Barrios and Dan Mattei, and to the many people who have contributed to the development of EUROMOD. Originally maintained, developed and managed by the Institute for Social and Economic Research (ISER), since 2021 EUROMOD has been maintained, developed and managed by the Joint Research Centre (JRC) of the European Commission, in collaboration with Eurostat and national teams from the EU Member States. The results and their interpretation are the authors’ responsibility. The contents of this article reflect only the positions or opinions of the authors and not necessarily those of the European Commission or the Romanian Ministry of Finance. Authors Antonio F. AMORES Georgiana BALABAN Silvia DE POLI Ioana A. GAVRIL Chrysa LEVENTI Tamara M. NAE Mattia RICCI 3 Executive summary The 2022 cost of living crisis, triggered by the energy crisis, had a significant impact on households in Romania, highlighting the need for effective policy measures to mitigate the negative effects of inflation. This paper assesses the impact of the policy measures implemented by the Romanian government on income inequality and poverty using microsimulation techniques. Policy Context The Romanian government implemented a series of policy measures to mitigate the negative effects of inflation on households, including price caps and income support. These measures were designed to cushion the impact of inflation on households, particularly the most vulnerable ones. Main Findings The inflationary shock had a highly regressive impact on household welfare, with the poorest households experiencing a significantly higher welfare loss than the richer ones. The impact of inflation was highest in the lowest income deciles, with the bottom income decile suffering a welfare loss almost four times as large as the one of the ninth decile. The policy measures introduced by the government, including price caps and income support, had a cushioning effect on household welfare, but did not fully neutralize the negative effect of the inflationary shock on the poorest part of the population. The measures did, however, benefit the poorest households the most, with the welfare loss in the first decile significantly diminishing. The use of targeted measures is warranted to improve the welfare effect for lower-income households and further diminish income inequalities resulting from the energy crisis. The impact of automatic indexation alone was found to be small, but it acted as an automatic stabilizer and helped to preserve the purchasing power of vulnerable population groups. Related and Future JRC Work This paper contributes to the JRC's work on the distributional implications of policy measures in response to economic shocks. Future work will focus on assessing the impact of policy measures on income inequality and poverty in other EU Member States, as well as evaluating the effectiveness of different policy measures in reducing income inequalities. Quick Guide — What was the impact of the 2022 cost of living crisis on households in Romania?  The inflationary shock had a highly regressive impact on household welfare, with the poorest households experiencing a significantly higher welfare loss than richer ones. — What policy measures were implemented by the Romanian government to mitigate the negative effects of inflation on households?  Price caps and income support were introduced to cushion the impact of inflation on households. — What was the effect of these policy measures on household welfare? 4  The measures had a cushioning effect on household welfare, but did not fully neutralize the negative effect of the inflationary shock on the poorest part of the population.  The targeted measures improved the welfare of lower-income households and diminished income inequalities resulting from the energy crisis.  The automatic indexation acted as an automatic stabilizer and helped to preserve the purchasing power of vulnerable groups, albeit to a small extent. 5 1 Introduction Consumer prices have risen significantly since mid-2021, peaking towards the end of 2022 and decelerating afterwards. Alongside the gradual economic recovery from the COVID-19 crisis, supply chains faced various constraints, while energy demand was boosted by continued support from governments and central banks. Several factors, including a series of weather-related events, have further strained energy supply. Subsequently, the shock caused by Russia’s invasion of Ukraine, which has significantly disrupted the energy trade in Europe, exacerbated an existing mismatch between energy demand and supply. Against the backdrop of an unprecedented crisis in the European energy system, energy prices reached historic highs in 2022, fuelling record inflation. In this context, many governments implemented measures to mitigate the impact of higher energy costs on households. These can be divided into two major categories: price-side interventions (e.g. retail price caps, regulated tariffs and reduced value added tax (VAT) / excises for energy products) and income support targeted at specific population groups. The design and effectiveness of such measures have been the subject of heated debates, especially within international institutions. The European Commission suggested a common approach among the EU Member States to implementing measures related to the energy crisis, which would target the most vulnerable groups, be fiscally affordable and maintain incentives for reducing energy consumption and improving energy efficiency (European Commission, 2022). The need for reducing energy demand has also been stressed by the Council of the European Union, which stated that energy measures must cover a limited amount of consumption, to maintain an incentive to reduce demand. This would also ensure fiscal affordability (Council of the European Union, 2022). The Organisation for Economic Co-operation and Development (OECD) argued in favour of moretargeted measures, shifting from price-side measures to income support, and highlighted the need to improve the design of the social welfare systems in place. This would ensure that the support provided is fair and effective, with limited fiscal and budgetary impact, sustaining market mechanisms for supporting the medium- to long-term transition to carbon-neutrality and ensuring energy security (OECD, 2022). The Romanian government has implemented both price and income-side policies. A price-capping scheme for natural gas and electricity prices was introduced in November 2021. Over time, the measure was extended and modified and, according to the present regulations in force, it will be valid until March 2025. Several income support measures were also implemented, aimed at diminishing the impact of high inflation on vulnerable populations. The most important measures concerned direct transfers/aids or vouchers for food or other goods granted to people at risk of poverty or in situations of material deprivation, including pensioners and students from low-income families. The net fiscal cost of the measures (considering taxes on windfall profits) was estimated to be about 0.6 % of the country’s gross domestic product in 2022. In this paper, we attempt to assess the impact of the policy measures implemented by the Romanian government in the context of the 2022 cost of living crisis on income inequality and poverty. Given their complicated design and the significant costs associated with them, assessing their distributional implications becomes of great importance. Our methodology involves a counterfactual analysis based on microsimulation techniques. To conduct the analysis, we made use of EUROMOD – the tax–benefit microsimulation model of the EU – and its newly developed Indirect Tax Tool (ITT). The model’s underlying microdata come from Eurostat’s European Union Statistics on Income and Living Conditions (EU-SILC) and the Household Budget Survey (HBS). 6 As stated by Süssmuth and Wieschemeyer (2022), the impact of inflation on income inequality is rather underexplored. The authors find that, in the case of the United States, the interaction between inflation and progressive taxation significantly favours low-income groups in terms of their net income. However, the findings of Zheng et al. (2023) suggest that, in a model of growth based on research and development, inflation has inconclusive effects on income inequality; its impact can be positive, negative or U-shaped, depending on the relative dominance of wealth and skills. Since the unprecedented inflationary pressures have occurred and the policies adopted to cushion their negative effects have been implemented very recently, the literature regarding these issues is rather scarce, and includes mixed results. Capeau et al. (2022) examine the impact of several cushioning measures implemented in Belgium in the context of the current energy crisis using EUROMOD. They find that the aggregate impact of the measures is mainly in favour of the lowest income deciles, given that the measures other than the VAT cut for electricity have been highly targeted and therefore progressive. Other studies show that low-income households have been the most affected by the energy crisis and inflation (Claeys and Guetta-Jeanrenaud, 2022). Varga et al. (2022) find that the direct impact of the price increases has resulted in a rise in the share of energy consumption as a proportion of income in the EU from 2.5 % to 3.75 % for median-income households, and from 4.75 % to more than 6 % for the lowest income quintiles, which could amplify existing inequalities. However, Blake and Bulman (2022) find that low-income households are not always the most affected, as the largest losses of real income depend on the type of energy the households consume and the corresponding price increases, and on the share of energy in household consumption. In every Member State, households in the lowest income deciles are more affected by increased home energy prices than those in higher income quintiles. However, when it comes to fuel prices, in several countries high-income households seem to be more affected than low-income households. Varga et al. (2022) also analysed the impact of three different measures – fuel tax reduction, targeted income support and non-targeted income support – on different types of households. Their results show that targeted income support is the most effective measure for vulnerable households. Income policy measures seem to have a lower impact on greenhouse gas emissions than fuel tax cuts do. These cuts also increase reliance on imported fossil fuels and promote the consumption of fossil-fuel-intensive durable goods, undermining the goals of the European Green Deal. Some recent papers study the effect of the rising inflation on households’ well-being. The average impact of the energy crisis on households’ cost of living was estimated to be up to 10 % in 2022 in the EU (Ari et al., 2022; Menyhért, 2024). While the impact varied significantly across countries and regions, its effects have been found to be mostly regressive (Ari et al., 2022; Claeys and Guetta- Jeanrenaud, 2022). Vulnerable population groups in central and eastern European countries, such as low-income households, large families, the rural population and older people, seem to be the most affected (Menyhért, 2024). Inflation is estimated to increase material and social deprivation by 2 percentage points in the EU, while also increasing energy and monetary poverty by 5 percentage points. These effects are several times higher in some Member States (Menyhért, 2024). Our contribution to the literature is twofold. To the best of our knowledge, this is the first paper assessing the distributional impact of the measures implemented in the context of the recent cost of living crisis in Romania, including both the income-side measures, targeted at specific population groups, and those related to prices (i.e. price capping and fuel price reduction), concerning all the citizens of the country. Using microsimulation techniques, we are able to estimate the cushioning effect of each of those measures throughout the income distribution. The second novel aspect of this work is that we attempt to separate the impact of the abovementioned discretionary measures from the impact of policies that act as automatic stabilisers in the event of high inflationary 13 4 Results 4.1 The impact of the inflationary shock in Romania In this section, we discuss the impact of the inflationary shock on Romanian households. To isolate the impact of inflation, we consider the counterfactual scenario, in which the government’s response is silent – that is, no policies are adopted in response to the inflationary shock. Effectively, household welfare across the income distribution is affected by two factors: (i) the increase in consumption expenditure experienced by households across income deciles and (ii) the increase in nominal income. Both factors affect households heterogeneously. In particular, the impact of increasing consumption expenditure generally differs across the income distribution because of differences in consumption patterns among households. As a result of the price surge in 2022, low-income households were most affected by the increase in consumption expenditure, for two reasons. Firstly, they generally face higher effective rates of inflation, as depicted in Figure 2. That is because households at the bottom of the income distribution spend a larger share of their income on necessities such as home heating and food. These were precisely the main drivers of the 2022 price surge, as shown by Figure 3. Secondly, low-income households generally consume more than they earn, and hence have limited ability to finance the extra expenditure burden brought about by inflation. As a result, they generally suffer a larger welfare loss. Likewise, note that the impact of price policies introduced by the government was slightly lower for households in the first four deciles of the income distribution, given that their car fuel consumption (which was temporarily subsidised by the government) is rather low. On average, price-related policies reduced the effective rate of inflation by 4.8 percentage points across the income distribution (this can be seen by comparing counterfactual and actual inflation rates in Figure 2). Figure 2. Effective rates of inflation across income deciles (%) Source: Authors’ calculations based on EUROMOD results. Potential inflation cushioned by policies Actual inflation Counterfactual inflation (no policies) 0 2 4 6 8 10 12 14 16 12345678910 Inflation (%) Income decile 14 Figure 3. Inflation by main product categories (A) and their contributions to general inflation (B) (A) (B) Sources: Eurostat (prc_hicp _manr, prc_hicp_aind, prc_hicp_inw). On top of the unequal impact of inflation on consumption expenditure, nominal income growth across income groups was also unequal, as shown in Figure 4. Nominal wage growth is simulated 0 5 10 15 20 25 30 CP01 Food and non-alcoholic beverages CP02 Alcoholic beverages, tobacco and narcotics CP03 Clothing and footwear CP04 Housing, water, electricity, gas and other fuels CP05 Furnishings, household equipment and routine household… CP06 Health CP07 Transport CP08 Communications CP09 Recreation and culture CP10 Education CP11 Restaurants and hotels CP12 Miscellaneous goods and services Annual change (%) 4.1 12.0 0 2 4 6 8 10 12 2021 2022 Percentage points Other Transport Housing, water, electricity, gas and other fuels Alcoholic beverages, tobacco and narcotics Food and non-alcoholic beverages 15 using EUROMOD uprating factors ( 5 ). Uprating factors update sources of income, pensions and nonsimulated social benefits according to their (estimated) growth between the year to which the data refers (e.g. 2019) and the years of the simulations (e.g. 2021 and 2022). While these rates of growth are the same across individuals (e.g. we do not simulate the income-decile-specific growth rate of earnings), the different composition of income for households at different points of the income distribution means the nominal income growth was actually quite different across income groups. To rationalise this, one might think of the difference between the income sources for the bottom deciles and for the top ones. Households at the bottom of the income distribution typically rely on pensions and social benefits, while, for households sitting at the top of the income distribution, market income is generally the main driver of nominal income growth ( 6 ). Income growth for the first two deciles stood at around 16 %, decreasing to just over 12 % for the third decile and to around 10 % for the fourth and fifth deciles, while being stable around 9 % for the second half of the income distribution. Figure 4. Income growth by income decile in 2022 (%) Source: EUROMOD uprating factors.Figure Figure 5 presents the overall impact of the inflationary shock on household welfare through income and consumption, in the absence of a policy response. As we can appreciate from the figure, the impact is highly regressive: the first income decile suffered a welfare loss almost four times as ( 5 ) Detailed information on the data source of each uprating factor is documented in the EUROMOD country report for Romania. ( 6 ) In this specific case, part of the increase in nominal income at the bottom of the distribution is explained by policy changes in means-tested benefits, not related to the energy crisis. 0 5 10 15 20 25 30 35 40 1 2 3 4 5 6 7 8 9 10 Income growth (%) Income decile 16 large as the one for the ninth decile, while the richest 10 % of the households appear least affected. Even though the income growth for the lowest incomes deciles was higher than for the highest ones, the impact of inflation on household welfare is almost five times as large for the bottom as for the top, given the differences in the structure of consumption expenditure across the income distribution. Figure 5. Impact of the inflationary shock on household welfare (no policies) Source: Authors’ calculations based on EUROMOD results 4.2 The cushioning effect of policy measures From the previous section, we learnt that in absence of policy measures the impact of the inflationary shock would have been least significant for the richest households. The impact would have been rather dramatic for the lowest-income households, with the bottom income decile suffering a loss of almost 40 % of their welfare compared with 2021. We now consider to what extent the policy measures introduced by the Romanian government (discussed in detail in Section 2Error! Reference source not found.) were able to shelter households across income groups. In doing so, we break down the role played by income-side measures, mostly aimed at supporting household income, on the one hand; and price-side measures, mostly aimed at limiting the increase in prices, on the other hand. We recall that the income-side measures were highly targeted at vulnerable social groups, while price-side policies benefited households across the board. -45 -40 -35 -30 -25 -20 -15 -10 -5 0 12345678910 Welfare variation (%) Income decile 17 Figure 2. Impact of inflation on household welfare with government policies Source: Authors’ calculations based on EUROMOD results Figure Figure 2 displays the impact of inflation on household welfare considering the cushioning effect of government measures. From the figure, we can see how the poorer households have benefited the most from government measures. In particular, the welfare loss in the first decile has significantly diminished (from 38.7 % in the absence of the measures to 5.4 % with the measures applied). Better-off households have also benefited to such an extent that their welfare impact becomes positive. This means that these households have actually improved their pre-inflationary shock situation. This is largely because a significant part of the cushioning effect was determined by price-side measures, as can also be seen in the budget share of price measures (see Figure Figure 3). Overall, generous fiscal measures went a long way towards counteracting the negative impact on household welfare; however, the great reliance on price measures meant that government support was largely untargeted. As a result, significant losses remained uncompensated among the lowest-income households. Nominal income growth Discretionary policies (price-side) Discretionary policies (income-side) -50 -40 -30 -20 -10 0 10 20 30 40 50 1 2 3 4 5 6 7 8 9 10 Welfare variation (%) Income decile Inflation effect Total effect 18 Figure 3. Cost of measures by type NB: GDP, gross domestic product; SMEs, small and medium-sized enterprises. Source: Romanian Ministry of Finance. 4.3 Automatic versus discretionary policy Apart from the discretionary policies implemented in the unexpected context of high inflation and aimed at cushioning its negative impact on the population, other elements of the Romanian system acted as automatic stabilisers to reduce the impact of inflation. In particular, these elements included the indexation of certain income transfers, such as old-age and minimum pensions, the allowance for children and the minimum wage. According to the legislation, these policies are meant to be (partially) indexed to inflation and/or other indicators, such as real wage growth, to ensure the preservation of the purchasing power of the most vulnerable households. Most often in Romania such indexation takes place in an ad hoc way, through derogation from certain rules. For instance, although a Swiss rule for pension indexation has been intended to be enforced by law, in recent years pension indexation has been done in an ad hoc way. Despite derogations from these indexation rules, such policies do act as automatic stabilisers to cushion the impact of inflation. Table 2 depicts the population coverage and monthly values of those policies in 2022. It also provides a breakdown of the actual indexation rules applied in 2022 into discretionary and nondiscretionary (automatic stabilisers) rules. We can see that the share of the population benefiting from these policies is rather high. For instance, in 2022 Romania registered almost 5 million pensioners (26 % of the total population), of whom about 20 % were paid the social allowance for pensioners (a top-up amount that brings the net pension received to a minimum threshold). In addition, the allowance for households with children aged 2–18 years benefited almost 19 % of the total population, while about 23 % of Romanian employees earned the minimum wage (1.2 million employees, or 6.3 % of the total population). 0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 Compensation for energy bills for SMEs and other institutions Compensation for energy bills for households Fuel reimbursement Support for low-income pensioners Financial for aid pensioners Food vouchers Price measures Income measures Percentage of GDP 19 Table 2. Statutory versus discretionary indexation of certain policies in Romania, 2022 Policy Population share (%) Indexation Monthly value (EUR) Actual (%) Statutory (automatic stabiliser) (%) Discretionary (%) Old-age pensions (pension point value (*)) 20.8 10 5.0 5.0 321 Social allowance for pensioners (minimum pension) 5.2 25 5.3 19.7 202 Allowance for children aged 2–18 years 18.8 13.5 5.3 8.2 49 Minimum gross wage 6.3 11 5.3 5.7 517 (*) An indicator used to calculate pensions. According to law, the pension point value is indexed every year in accordance with the indexation rule: inflation rate + 50 % of the rate of growth of the real wage. Source: Romanian Ministry of Finance. Given the relatively large share of the population benefiting from these indexation rules (over 50 %), and as the annual average inflation rate stood at 13.8 % in 2022, the abovementioned policies significantly contributed to the maintenance of households’ purchasing power. The welfare impact of direct discretionary policies, price measures, discretionary indexation and other policies, by income decile, is depicted in Figure 8. Figure 9 splits the overall policy indexation effect into discretionary and automatic (statutory) effects. As already discussed, inflation had a larger negative impact on the lowest income deciles, especially the poorest one. Market income developments had a more pronounced positive impact on richer households, and a slightly negative effect on households in the first decile. As expected, the effects of both automatic and discretionary indexation were more favourable for the lower half of the income distribution, benefiting rich households less. Still, as shown in Figure 9, discretionary indexation was more progressive than automatic indexation. Likewise, price measures positively affected the first three deciles to the largest extent. They also positively affected the rest of households, given that price caps were targeted based on not income but energy consumption. However, direct discretionary policies were found to have mostly favoured the poorest 50 % of the population, with an insignificant impact on the richest half of the income distribution, as these measures were targeted at low-income households. 20 Figure 4. Impact of discretionary and automatic measures on household’s welfare Source: Authors’ calculations based on EUROMOD results. Figure 5. Discretionary versus automatic indexation Source: Authors’ calculations based on EUROMOD results. -50 -40 -30 -20 -10 0 10 20 30 40 50 12345678910 Welfare variation (%) Income decile Discretionary direct policies Price measures Discretionary indexation Other policies Automatic indexation Market income Inflation Welfare effects Automatic indexation Discretionary indexation 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Welfare Variation (%) Income decile 21 5 Conclusions Romania exhibits one of the highest rates of poverty and inequality in the EU. The recent increase in the cost of living has made the population of Romania even more vulnerable, triggering a bold policy response from the government through the adoption of both price and income-side support measures. This paper uses microsimulation techniques to assess the impact of the 2022 inflationary shock on Romanian households and the effect of the policy measures adopted by the government, in terms of welfare and inequalities. We construct three counterfactual scenarios to depict the actual impact of the inflationary shock on the population: one in the presence of price and income-side support measures, one in the hypothetical absence of these measures and one that captures the cushioning effect of discretionary policy measures introduced by the Romanian government. We find that the inflationary shock had an uneven effect on households through consumption expenditures. The impact was higher on lower-income households than on higher-income ones, given that they spend a larger share of their income on basic needs, for example home heating and food – which were the main drivers of the 2022 price surge – and, at the same time, save little or not at all. Moreover, the effect generated by nominal income growth also differs significantly along the income distribution, partially offsetting differences between higher- and lower-income households. However, the inflationary shock, tested in the absence of policy measures, remained highly regressive, with poorer households experiencing a significantly higher welfare loss than richer ones. As regards the impact of the policy measures adopted by the government (income-side measures, price-side measures and discretionary indexation), we find that households in the first decile of the income distribution benefited the most. However, the large impact of the inflationary shock on these households was such that significant losses remained. On top of discretionary policies, some automatic indexation measures related to inflation were implemented that mainly acted as automatic stabilisers and helped to preserve, at least partly, the purchasing power of some of the vulnerable groups of the population. Still, the impact of automatic indexation alone was found to be small. 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