Exchange rate shocks and household welfare

This article examines the impact of exchange rate shocks on household welfare in Malawi by addressing two questions: (i) by how much do exchange rate shocks affect household welfare, and (ii) through which channels do these effects operate? We combine empirical and theoretical approaches. Empirically, we estimate exchange rate pass-through (ERPT) to prices of goods and services in the representative household’s consumption basket using a Bayesian structural vector autoregressive model applied to monthly Malawian data from 2019 to 2024. We then use the fifth wave of the Malawi Living Standards Measurement Survey to compute household exposure to these price changes, distinguishing between poor and non-poor households. Finally, we combine estimated price responses with exposure measures to quantify welfare effects through changes in household consumption. We find that a 1% exchange rate depreciation reduces household welfare by 11.04%, with non-poor households experiencing relatively larger adverse effects. Theoretically, we develop a New Keynesian model calibrated to Malawi. In the model, poor households are affected primarily through real wage income, while non-poor households experience additional losses through both real wages and profits/dividends, resulting in larger consumption declines. These results highlight the importance of exchange rate stability for protecting household welfare in import-dependent economies. This study quantifies the welfare cost of local currency depreciation and demonstrates how these costs differ between poor and non-poor households in an import-dependent economy. The findings provide timely evidence for policymakers in Malawi as they address persistent foreign exchange shortages, rising import dependence, and recurring calls for currency devaluation, including those from the International Monetary Fund (IMF). By showing that exchange rate adjustments have important and unequal welfare consequences across households, the study provides evidence to inform exchange rate management, monetary policy, and social protection measures. Beyond Malawi, the study offers a practical framework for assessing the household welfare effects of exchange rate shocks in other developing economies pursuing macroeconomic stability while advancing long-term development goals such as the Malawi 2063.