Pandora’s revenge

In August 2015, the central bank of Kazakhstan took its mitts off the exchange rate, leaving it to the vagaries of the currency market. From July to September, the number of tenge trading for a dollar rose from 187 to 258 – and averaged 366 in January, a virtual doubling in five months. In other words, the amount of foreign goods that tenge holders could buy nearly halved. Who suffered most in this drastic depreciation?

At first glance, you would think that the rich had more to lose than the poor. Those with tenge wealth saw their dollar value vanish. The poor had no wealth, much less tenge wealth, so they got off scot-free.

At second glance, things are not so simple.  A depreciation raises local prices, since it raises foreign demand for local goods, forcing residents to compete for them by paying more.  Some prices rise faster than others. Who is unlucky enough to face these prices?

A recent study addressed this question by analyzing the 1994 crash of the Mexican peso.  Political violence and other factors that year caused investors to lose faith in the peso.  To keep it from weakening in terms of the dollar, the central bank bought pesos and sold dollars.  Since the peso was overvalued, investors dumped it. By December, the central bank was running out of dollars, so it floated the peso. The currency tanked, prices soared, and a few banks collapsed.  Sound familiar?   

In their careful study of the Mexican crisis, Javier Cravino and Andrei Levchenko concluded that prices paid by the poorest tenth of the population nearly doubled while those paid by the richest tenth rose three fourths. This happened partly because the rich spent more of their income on services than the poor did. Most services are bought at home, not abroad; so when the currency goes south, their prices rise less rapidly than those of traded goods like grain.  Even within a category like food, prices rose more rapidly for the poor, who were accustomed to buying cheap food from abroad.  Overall, in the two years following the swooning of the peso, the purchasing power of the poor fell by half but declined less rapidly – by 40% -- for the rich.

Did the 2015 tenge crisis worsen the income distribution in Kazakhstan as well?  A question, perhaps, for the National Bank. --Leon Taylor, tayloralmaty@gmail.com

Good reading

Aldo Musacchio. Mexico's financial crisis of 1994-1995.  Harvard Business School Working Paper. No. 12–101. May 2012. 

Wikipedia.  Mexican peso crisis.  https://en.wikipedia.org/wiki/Mexican_peso_crisis

References

Javier Cravino and Andrei A. Levchenko.  2017. The distributional consequences of large devaluations.  American Economic Review 107(11): 3477–3509. https://doi.org/10.1257/aer.20151551.

National Bank of Kazakhstan.  Official exchange rates on average for the period.  www.nationalbank.kz