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The Distributional Consequences of Exchange Rate Devaluations

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  • Andrei Levchenko

    (University of Michigan)

  • Javier Cravino

    (University of Michigan)

Abstract

We study the differential impact of large exchange rate devaluations on the cost of living at different points on the income distribution. Across product categories, the poor have relatively high expenditure shares in tradeables. Within tradeable product categories, the poor consume lower-priced varieties that contain relatively less domestic value added. A devaluation raises the relative price of tradeables, and within product categories raises the relative price of cheaper varieties. Both effects imply that the devaluation hurts the low-income households more than the high-income ones. We quantify these effects following the 1994 Mexican peso devaluation and show that the distributional consequences can be large. Following the devaluation, the cost of the consumption basket of those in the bottom decile of the income distribution rose between 1/3 and 1/2 times more than the cost of the consumption basket for the top income decile. We supplement the detailed results for Mexico using cross-country evidence.

Suggested Citation

  • Andrei Levchenko & Javier Cravino, 2015. "The Distributional Consequences of Exchange Rate Devaluations," 2015 Meeting Papers 1060, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1060
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    File URL: https://economicdynamics.org/meetpapers/2015/paper_1060.pdf
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    References listed on IDEAS

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    1. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2005. "Large Devaluations and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 113(4), pages 742-784, August.
    2. Berger, David & Faust, Jon & Rogers, John H. & Steverson, Kai, 2012. "Border prices and retail prices," Journal of International Economics, Elsevier, vol. 88(1), pages 62-73.
    3. Jed Friedman & James Levinsohn, 2002. "The Distributional Impacts of Indonesia's Financial Crisis on Household Welfare: A "Rapid Response" Methodology," World Bank Economic Review, World Bank Group, vol. 16(3), pages 397-423, December.
    4. Ahlin, Christian & Shintani, Mototsugu, 2007. "Menu costs and Markov inflation: A theoretical revision with new evidence," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 753-784, April.
    5. Jerry Hausman, 2003. "Sources of Bias and Solutions to Bias in the Consumer Price Index," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 23-44, Winter.
    6. Porto, Guido G., 2006. "Using survey data to assess the distributional effects of trade policy," Journal of International Economics, Elsevier, vol. 70(1), pages 140-160, September.
    7. Etienne Gagnon, 2009. "Price Setting during Low and High Inflation: Evidence from Mexico," The Quarterly Journal of Economics, Oxford University Press, vol. 124(3), pages 1221-1263.
    8. Linda S. Goldberg & José Manuel Campa, 2010. "The Sensitivity of the CPI to Exchange Rates: Distribution Margins, Imported Inputs, and Trade Exposure," The Review of Economics and Statistics, MIT Press, vol. 92(2), pages 392-407, May.
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