The Inflationary Impact of a Large Devaluation across the Income Distribution: The Case of Egypt in 2016

Abstract

Abstract Large-scale currency devaluations often result in rapid inflation, disproportionately affecting households with lower incomes, as they typically allocate a higher portion of their expenses to tradable goods. In this study, we examine cost-of-living changes of households across the income distribution in a relatively highly regulated, modest-inequality economy—Egypt—following the November 2016 devaluation of the Egyptian Pound when it depreciated by approximately 50%. We model the exchange rate pass through to domestic prices of various commodities, and the consumption responses by distinct economic groups, using true cost-of-living indices. We first quantify the exchange-rate pass-through to commodity prices, and then introduce a readily applicable methodology based on minimal data requirements to study the distributional implications for households’ cost of living and welfare, taking substitution effects and changes in preferences into consideration. Our findings reveal that over 30% of the rise in the cost of living of the average household was due to the devaluation, raising the amount of compensating variation necessary to keep households at their 2015 real welfare levels by 30% to 40% compared to the counterfactual scenario absent devaluation. These effects were more pronounced for some regions and among the poorest households. These disparities in welfare effects underscore the importance of designing and implementing targeted transfers to mitigate the negative impact of similar devaluations.