Unequal expenditure switching: Evidence from Switzerland

Revised November 2023

Summary

Focus

How do import prices affect inequality via their varying effects on the cost of living? When the Swiss National Bank removed the Swiss franc's exchange rate against the euro in January 2015, a unique opportunity arose to test methods of measuring welfare changes in response to changes in import prices. The episode was unique because the policy change resulted in a large and unexpected surge in the domestic currency's value when the macroeconomic environment was otherwise stable. Further, full microeconomic data on prices were available, as well as information on consumer spending and the currency of invoicing at the border.

Contribution

The welfare effects of price changes for imported goods can very between different classes of consumers due to differences in their initial expenditure shares for imported goods and differences in how they replace imported with domestic goods or vice versa, ie "expenditure switching". The literature has thus far focused on the former channel, mostly owing to the difficulty of uncovering the underlying price elasticities between imported and domestic goods. Using data from Switzerland surrounding the 2015 appreciation of the Swiss franc, our contribution is to estimate the underlying parameters and to highlight the quantitative importance of these two channels.

Findings

We find that demand from lower-income households is substantially more price elastic than that of high-income households. This has significant implications for the distributional impact of changing import prices. We use two distinct quantitative approaches to estimate differences in the elasticity of substitution across incomes. In the first approach, we use the variation in changes in expenditure on imported relative to domestic goods, as recorded for higher- and lower-income households. In a second approach, we use the variation in expenditures across individual products and in product price changes. We also quantify the distributional welfare implications of counterfactual changes in import prices. For example, in response to a fall in import prices, low-income households would benefit more because they have higher price elasticities and, hence, will more readily replace domestic with imported goods. On the other hand, high-income households stand to benefit more because they have higher initial shares of imported goods.

Abstract

What are the unequal effects of changes in consumer prices on the cost of living? In the context of changes in import prices (driven by, e.g., changes in trade costs or exchange rates), most analyses focus on variation across households in initial expenditure shares on imported goods. However, the unequal welfare effects of non-marginal foreign price changes also depend on differences in how consumers substitute between imported and domestic goods, on which there is scant evidence. Using data from Switzerland surrounding the 2015 appreciation of the Swiss franc, we provide evidence that lower-income households have higher price elasticities. We quantify the contribution of heterogeneous elasticities for the unequal welfare effects of observed price changes between 2014–15 and for counterfactual shocks to the mean and dispersion of import price changes.

JEL classification: E3, F1, F41.

Keywords: expenditure switching, large exchange rate shocks, gains from trade.