Income-Induced Expenditure Switching

60 Pages Posted: 2 Jun 2014  

Rudolfs Bems

International Monetary Fund (IMF); European Central Bank (ECB)

Julian di Giovanni

Universitat Pompeu Fabra - Department of Economics and Business; Barcelona Graduate School of Economics (Barcelona GSE); CREI and Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR)

Date Written: March 2014

Abstract

This paper shows that an income effect can drive expenditure switching between domestic and foreign goods. We use a unique Latvian scanner-level dataset for food and beverages, covering the 2008-09 financial crisis, to study (i) relative price movements, and (ii) expenditure switching between domestic and imported goods. We document several empirical findings. First, imports contracted by 26%, with expenditure switching accounting for one third of the fall, while the relative price of foreign goods viz. the food CPI increased by 4.4% during the crisis. Second, the majority of the switching took place between items within narrowly defined product groups, while the relative price adjustment was across product groups. This puzzling asymmetry in expenditure and price adjustments, combined with a finding that consumers substituted towards lower unit value domestic items during the crisis, motivate us to model non-homothetic consumer demand. Over the crisis period, the estimated model explains eighty percent of the observed expenditure switching, which was driven almost entirely by an income effect.

Keywords: Crisis, Expenditure switching, Non-homothetic preferences, Relative price adjustment

JEL Classification: F1, F3, F4

Suggested Citation

Bems, Rudolfs and di Giovanni, Julian, Income-Induced Expenditure Switching (March 2014). CEPR Discussion Paper No. DP9887. Available at SSRN: https://ssrn.com/abstract=2444908

Rudolfs Bems (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Julian Di Giovanni

Universitat Pompeu Fabra - Department of Economics and Business ( email )

Barcelona
Spain

HOME PAGE: http://julian.digiovanni.ca

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

HOME PAGE: http://julian.digiovanni.ca

CREI and Universitat Pompeu Fabra ( email )

HOME PAGE: http://julian.digiovanni.ca

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

HOME PAGE: http://julian.digiovanni.ca

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