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Inter-country trade dependence and inflation transmission mechanisms: The case of a small open African economy

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  • João Tovar Jalles

Abstract

Purpose – According to the Central Bank of Cape Verde, price stability is an important aspect when conducting its monetary policy. Given the fixed exchange rate regime towards the Portuguese Escudo/Euro and the high degree of trade inter-dependence, this paper aims to analyse the “inflation import” phenomenon from Portugal to Cape Verde's economy from 1992 to 2008. Design/methodology/approach – The paper takes a VECM and Granger causality approach. Findings – The paper finds evidence in favour of the existence of a propagation mechanism, i.e., inflation transmission from Portugal to Cape Verde. The reverse conclusion is not true though. Another interesting implication from the policy-making perspective is that Cape Verde's CPI is affected by non-expected shocks in the short run and it takes, on average, 12 months for an adjustment towards a higher level to take place. Practical implications – So, Portuguese inflation is an important variable to take into account when doing inflation forecasting exercises to Cape Verde's economy as well as when thinking about setting/defining exchange rate regimes. In this context, diversifying trading partners in Cape Verde is highly recommended as a way to reduce and dilute the Portuguese influence (as well as the role of external shocks) in the overall economy and price levels in Cape Verde. Originality/value – The paper applies a well-known economic phenomenon to the relationship between Portugal and one of its former colonies – Cape Verde. The analysis is of use to policy practioneers and to the country's Central Bank.

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Bibliographic Info

Article provided by Emerald Group Publishing in its journal International Journal of Development Issues.

Volume (Year): 9 (2010)
Issue (Month): 3 (July)
Pages: 198-213

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Handle: RePEc:eme:ijdipp:v:9:y:2010:i:3:p:198-213

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Related research

Keywords: Cape Verde; Forecasting; Imports; Inflation; International trade; Portugal;

References

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  1. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
  2. Rodrigo Fuentes & Federico Sturzenegger, 1993. "Growth issues in developing countries: an overview," Estudios de Economia, University of Chile, Department of Economics, vol. 20(esp Year ), pages 1-18, june.
  3. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  4. Dickey, David A & Pantula, Sastry G, 1987. "Determining the Ordering of Differencing in Autoregressive Processes," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(4), pages 455-61, October.
  5. Michael R. Darby & James R. Lothian & Arthur E. Gandolfi & Anna J. Schwartz & Alan C. Stockman, 1983. "The International Transmission of Inflation," NBER Books, National Bureau of Economic Research, Inc, number darb83-1.
  6. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  7. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
  8. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-38, July.
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