Exchange Rate Shocks and Quality Adjustments

Abstract

How do firms change the quality composition of their traded goods in response to an exchange rate shock? Using unique data from a large Russian retailer that varies its offerings across seasons, we document that ruble devaluations are associated with a reduction in the observed material and fabric quality of goods the retailer imports for resale. Our results indicate that an increase in the retailer's costs, as opposed to a reduction in demand due to shrinking real incomes, is the driving force. We estimate a simple multi-product sourcing model to quantify the welfare impact of quality adjustments and find that preventing firms from downgrading overstates the welfare loss from the 2014 ruble devaluation by 33%, while incorporating cost heterogeneity but ignoring quality has ambiguous effects on welfare changes in general.

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

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