THE IMPACT OF EXCHANGE RATE VOLATILITY AND DOLLARIZATION ON PURCHASING POWER IN LEBANON

Abstract

This study investigates the profound impact of exchange rate volatility and dollarization on purchasing power in Lebanon, a nation enduring one of the worst economic crises since the mid-19th century following the collapse of its fixed exchange rate peg in October 2019. Addressing a critical gap in the literature, this research quantitatively estimates the magnitude and velocity of exchange rate pass-through (ERPT) to domestic inflation and approximates the subsequent loss in real purchasing power for Lebanese Lira (LBP) earners amidst conditions of extreme financial dollarization. Utilizing an Autoregressive Distributed Lag (ARDL) framework on monthly data from October 2019 to March 2024, our findings reveal an exceptionally strong and rapid ERPT. The long-run coefficient for the parallel-market exchange rate on the Consumer Price Index (CPI) is estimated at 0.98, indicating an almost one-to-one pass-through. Furthermore, approximately 85% of this pass-through occurs within just two months of an exchange rate depreciation. This rapid and near-complete transmission, driven by extreme import dependency, a complete loss of confidence in the Lira, prevalent dollarized pricing practices, and a hyperinflationary environment, led to a catastrophic decline in LBP purchasing power, which plummeted to roughly 26% of its pre-crisis level by March 2024. In stark contrast, "fresh dollar" earners saw their purchasing power for local goods and services surge to over 600%, highlighting a severe economic bifurcation. The study concludes that de facto dollarization acts as both a consequence of the Lira's collapse and a powerful cause perpetuating the crisis by reducing demand for the Lira, increasing exchange rate volatility, and rendering monetary policy ineffective. Policy recommendations emphasize immediate USD-denominated social protection programs and comprehensive, IMF-backed macroeconomic reforms focusing on exchange rate unification, fiscal consolidation, and banking sector restructuring to stabilize prices and restore confidence.