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Appendix I. Additional Material and Data Sources
Prepared by Frederik Toscani.
Recall that we find that overall consumption falls as a consequence of depreciations—expenditure switching from imports to domestic goods does happen but as long as overall consumption falls this.
In a recent publication on external adjustment in Latin America and the Caribbean (WHD April 2017 REO) the IMF showed that while a negative income effect dominated in most countries in the region, a positive expenditure switching effect has become more important over the past years.
Ideally, one would like to be able to have household-level panel data which capture microeconomic heterogeneity in expenditures, income, assets and debt to be able to isolate and estimate each channel. Given the very substantial data constraints, this paper will analyze the link between exchange rate movements and consumption through several complementary but partial approaches to shed more light on the question.
Much of the discussion in this section is based on Carroll (2001) and Kaplan et al. (2014) (as well as Mark Aguiar’s and Karen Pence’s comments on Kaplan et al.). Also see Carroll (2013) for an overview of the current state of the consumption literature and the importance of acknowledging the fact that aggregate consumption behavior cannot be well captured by a representative household but that heterogeneity in income, assets and potentially preferences are crucial.
Indeed, empirical evidence suggests that this works reasonably well for large fluctuations (see, for example, Hsieh, 2003).
See for example saver-spender models where impatient spenders borrow from patient savers and consume all their income every period (Gali et al., 2006).
Apart from optimal portfolio allocation, wealthy HtM consumers can also arise following a large negative shock or extreme impatience. Hyperbolic discounters might be wealthy HtM consumers to protect themselves against future excessive consumption, for example.
A good which does not depreciate at all is equivalent to wealth.
Consumers attempt to smooth the service flow of durable services rather than expenditure on durables. Of course, when households are liquidity constrained they cannot smooth as desired (see above discussion on HtM consumers).
The survey was conducted by the Economics department of the Universidad de la Republica. The design is based on the Bank of Spain’s “Encuesta Financiera de las Familias espanolas” as well as the Bank of Italy’s “Survey of Household Income and Wealth” and the Chilean Central Bank’s “Encuesta Financiera de Hogares”. The baseline sample is derived from the Uruguayen Statistic Institute’s 2012 version of the continuous household survey (ECH- 2012). Given the high concentration of wealth in Uruguay—as in other countries—the EFHU-2 survey over-samples very high income and wealth households. Using the appropriate survey weights, the data is representative of households in urban areas in Uruguay. See methodological guide (“Metodologia y guia para el usario EFHU-2) published in August 2016 for further details.
We calculate HtM status in two preferred ways. (i) based on the ratio of liquid assets to income and (ii) based on the response to a survey question which asks households whether they spent more, as much or less than their income over the past year. For this measure, HtM households are defined as those which consume as much or more than their income. For measure (i), note that we do not subtract any debt from liquid assets since we do not have a measure of credit card debt which is what Kaplan et al. (2014) use. In that sense our measure is a lower bound for the share of HtM households. We get to the 40 percent number when we only consider households with 0 or negative net total (rather than liquid) wealth as HtM.
Kaplan et al. (2014) calculate the share of HtM households and the prevalence of wealth HtM households using survey data from the US, UK, Canada, Australia, Germany, France, Italy and Spain. Our numbers are not directly comparable to theirs given a somewhat less granular analysis in the present study but it is nevertheless clear that while HtM households make up a significant portion of the population in advanced economies, the fraction is much higher still in Uruguay.
For the U.S. the split is about 2/3—1/3.
Note that we do not have data on real disposable income but only a real wage index. This blurs the interpretation of results to some degree.
Tests are done for the series with and without a linear trend.
et ≡ exchange rate, yt ≡ real income index, ct ≡ consumption. We also estimate a larger model which includes 12-month interest rates and employment. Results become more sensitive to the ordering but the basic result on the impact on real income and the exchange rate on consumption remains. See Matheson and Goes (2017) for a similar VECM for consumption in Brazil.
Note that the persistence of the impact of shocks is somewhat built-in to the analysis through the long-run relationship of the VECM where both real wages and the exchange rate enter significantly.
As we will see below there is huge heterogeneity in terms of pass-through by good.
We include a time trend in the regressions so that the exchange rate coefficient can be interpreted as the reaction to a deviation from the expected trend. As noted before, this is relevant given that the Peso tends to slowly trend-depreciate against the USD and agents expect it to do so.
When we exclude real wages from the regression in column 1, the coefficient on the exchange rate becomes significant, again indicating that the income channel of exchange rate movements is indeed relevant.
The Appendix shows a table with pass-through by item for those items in the right tale of the pass-through distribution. The appendix also lists all USD-quoted goods and services which are part of the CPI.
Hedging against exchange rate and inflation shocks is of course one of the key reasons for households to hold dollar assets.
Note that the magnitude of the ratio cannot be easily interpreted since the nominator is an index of consumer goods imports while the denominator is private consumption in constant 2005 Pesos.
Also see Obstfeld and Rogoff (1996) for the basic point that durable goods increase current account volatility.
Variables are in logs and de-trended using an HP filter. The ratio of volatilities for the de-trended series in Uruguay is 1.14.
The two mechanisms are potentially observationally equivalent if exchange rate movements lead to interest rate movements to satisfy interest rate parity. In the mechanism here proposed the nominal exchange rate would need to be an exogenous parameter. Anecdotal observations for Uruguay does not make it seem unlikely though that global factors are a key driver of the Peso.