VoxEU Column Exchange Rates Monetary Policy

The anti-poor distributional effects of large exchange rate devaluations

Large exchange rate swings remain a prominent and recurring feature of the world economy. This column uses household consumption patterns to examine the distributional impact of the devaluation of the peso during Mexico’s ‘Tequila Crisis’. Cost of living increases are found to be 1.25 to 1.6 times higher for the poor compared to the rich. In the interests of equity, exchange rate policy should take account of such distributional impacts.

The dramatic devaluations of the Russian ruble and Ukrainian hryvnia in 2014, and the instantaneous 20% appreciation of the Swiss franc against the major currencies on 15 January 2015, are only the latest reminders that large exchange rate swings remain a prominent and recurring feature of the world economy. Exchange rates are frequent targets for policies (such as pegs or interventions), and it is important to understand their impact. There is a substantial literature on macro adjustment following large changes in real exchange rates. This literature studies the pass-through to domestic prices, as well as the response of macro aggregates such as imports, exports, and gross domestic product (see Burstein and Gopinath 2015 for a recent survey).

However, there is very little research on whether exchange rate changes affect different types of households differently. This is potentially a first-order phenomenon. A large change in the exchange rate leads to changes in relative prices inside the economy (even though the pass-through to domestic prices is far from complete). It is well known that households at different income levels consume very different baskets of goods. A change in relative prices following a large exchange rate change will thus affect households differentially, implying that exchange rate changes have a distributional as well as an aggregate welfare impact.

In a recent paper we evaluate the distributional impacts of large exchange rate changes using micro data on consumer expenditures and prices (Cravino and Levchenko 2015). We use primarily the devaluation of the Mexican peso during the 1994 Tequila Crisis as the ‘laboratory’ to study these effects. For this episode, we observe monthly price quotes on about 30,000 unique product-outlet level prices that the Bank of Mexico uses to construct the consumer price index, and household-level consumer expenditure surveys both immediately before and after the crisis.

We distinguish two types of differences in household consumption baskets, which we label Across and Within. Across product categories, low-income households spend relatively more on tradeables (such as food), while high-income households spend relatively more on non-tradeables (such as personal services). Within product categories, low-income households spend relatively more on lower-end goods purchased from lower-end retail outlets. Changes in the relative price of tradeables and of low-priced varieties following a large devaluation will thus affect households differently, generating a distributional welfare impact.

The Across price index shows that in the two years following the devaluation, the consumers in the bottom decile of the Mexican income distribution experienced cost of living increases about 1.25 times larger than the consumers in the top income decile. The increase in the price index was 95% for households in the poorest decile, compared to 76% for households in the richest decile. The effect is monotonic across all income deciles, as illustrated in Figure 1.

Figure 1. The Across price index by household income

Note: This figure reports the local polynomial fits of the household-specific price level changes against log income, together with 95% confidence intervals. The household-specific price indices are calculated based on the 284 9-digit consumption categories and 1994 expenditure weights. Income is taken from the 1994 household survey.

We then compute a ‘Within’ price index, which assumes that high- and low-income households spend the same share of their income across product categories, but that within each category, the high-income households consume the more expensive varieties, and the low-income the less expensive ones. In our benchmark index, the Within effect implies that inflation for the lower-income consumers was between 13 and 21 percentage points higher than for the higher-income consumers.

The Across and Within effects are roughly additive, reinforcing each other. Figure 2 depicts the comparison of consumption price indices of a hypothetical low-income and a hypothetical high-income household. The low-income household is defined as one that has across-goods expenditure shares of a household in the bottom income decile, and on top of that consumes the cheaper varieties within each good. The high-income household has across-goods expenditure shares of the top income decile, and within each good consumes the more expensive varieties. Our preferred estimate of the price index that combines these two effects implies that the households in the bottom decile of the Mexican income distribution experienced increases in the cost of living between 1.46 and 1.6 times higher than the households in the top decile in the two years that follow the devaluation.

Figure 2. The overall price indices for high- and low-income consumers

Note: This figure plots the evolution of consumption price indices for a high-income household and a low-income household, both normalized to 1 in October 1994.

The main finding is thus that both the Across and the Within distributional effects were large and economically significant in the 1994 Mexican devaluation. Why was the devaluation anti-poor? We show that the poor spend a higher fraction of their income on tradeable product categories, and among tradeables, on categories with a systematically lower non-tradeable component. This is primarily driven by differences in distribution margins (transportation, wholesale, and retail) rather than by differences in the prevalence of local goods across categories. As the relative price of tradeables to non-tradeables increases following the devaluation, the prices paid by the low-income households rise by proportionally more than those paid by the high-income households. Another plausible mechanism that may underpin the Within effect is that higher-quality varieties have more variable markups, and thus those markups will fall by more following a devaluation. This would produce a decline in the relative prices of expensive varieties, favouring wealthier consumers. Auer et al. (2014) and Antoniades et al. (2015) provide empirical evidence that exchange rate pass-through is indeed lower for high-quality products.

Concluding remarks

The distributional consequences of exchange rate changes are a relatively unexplored consideration for exchange rate policies, in both a normative and a positive sense. If equity considerations are important, optimal policy should take the differential impact of exchange rate changes across income groups into account. By the same token, understanding how large exchange rate changes affect different consumers may be informative about the configuration of political support for policies – such as Grexit or Brexit – that will likely carry significant exchange rate implications.


Antoniades, A and N Zaniboni (2015) “Exchange rate pass-through into retail prices”,   International Economic Review, forthcoming.

Auer, R, T Chaney and P Sauré (2014) “Quality pricing-to-market”, Mimeo, Swiss National Bank and Toulouse School of Economics.

Burstein, A T and G Gopinath (2015) “International prices and exchange rates”, in K Rogoff, E Helpman and G Gopinath, eds., Handbook of International Economics, Vol. 4, Elsevier, chapter 7,  391 – 451.

Cravino, J and A A Levchenko (2015) “The distributional consequences of large devaluations”, November 2015, RSIE Discussion Paper 648.

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