While a common concern about cash transfers is the potential for inflation in local markets, a randomized antipoverty intervention in Yemen shows the opposite pattern. When income in treated villages was increased in the short term, the price of flour in local shops ended up about 10% lower than in control villages. I explain this counter-intuitive result as the result of interlinked transactions of insurance and food purchases. I show that village shop owners regularly offer store credit with flexible repayment and that this credit is used as a consumption smoothing mechanism by customers and is correlated with higher markup. In non-competitive markets, the presence of dynamic incentives means that this store credit can take on an insurance aspect. I model an informal contract in which the store sets the terms such that customers that experience random idiosyncratic shops always prefer buy at high prices from the shop. However, when average incomes increase, the store keeper needs to adjust the contract via dropping the price, because the demand for insurance has declined.
Sikandra Christian is a PhD candidate in the Agricultural and Resource Economics Department at University of California, Berkeley. She is interested in the interaction between existing informal institutions and the formal goals of government interventions in developing countries. Her current research is focused in Yemen, where she has spent considerable time in country and in the field and has an active collaboration on impact evaluations with the Social Fund for Development.