Discussion paper

DP16869 The Impact of a Large Depreciation on the Cost of Living of Rich and Poor Consumers

This paper shows that a large exchange rate depreciation affects the cost of living of rich and poor consumers differently. Interestingly, we show that rich consumers are less affected by the depreciation. This is because the depreciation introduces a large variety of products to the market which are more accessible to rich than to poor consumers. We exploit scanner data tracking consumer purchases before and after the large depreciation of the Kazakh Tenge, when it switched from a fixed to a floating exchange rate regime, in August 2015. We use an event study design to show that marginal costs increase more for foreign products than for local products after the depreciation. However, the retail margins on foreign products decrease by more than the retail margins on local products. Thus, the retailer limits relative price movement by adjusting its margins, which helps explain the low sensitivity of domestic absorption to changes in relative border prices. To examine the cost-of-living effect we decompose it into a cost, a retail markup, a substitution and a variety effect. As richer consumers spend, on average, more on foreign varieties, we find that they are disproportionally affected by the cost effect. However, lower retail markups after the shock offset this relative cost increase. Since richer consumers benefit more from changes in product variety, their cost of living increases by less after the depreciation.

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Citation

Colicev, A, J Hoste and J Konings (eds) (2022), “DP16869 The Impact of a Large Depreciation on the Cost of Living of Rich and Poor Consumers”, CEPR Press Discussion Paper No. 16869. https://cepr.org/publications/dp16869