Exchange Rate Shocks and Quality Adjustments

Abstract

Do firms respond to cost shocks by reducing the quality of their products? Using microdata from a large Russian retailer that refreshes its product line twice-yearly, we document that higher quality products are more profitable than lower quality ones before a large ruble devaluation in 2014, but are stocked relatively less frequently after the devaluation. We reconcile these facts with a simple model that features consumer expenditure switching between high and low qualities, and show that reallocation to lower quality products reduces average pass-through by 12%.

Keywords: Quality Downgrading, Exchange Rate Pass-through, Devaluations, Crisis, Demand Estimation

JEL Classification: D92, E30, F14, F31, L11, L15, L16, L81, M11