Food Price Volatility implications for Trade and Monetary Policy between Nigeria and CEMAC: a Bayesian DSGE model approach

Food price volatility has become a major challenge for trade in many commodity-oriented developing countries. In Africa, the growing concern is the suitable exchange rate regime to tackle the effect of volatility for trade intensification. According to the theory of international trade, exchange rate stability, by the reduction of transaction costs, stimulates investments and therefore intensify cross-border trade. The proposed research aims thus to emphasize food price volatility implications on the bilateral trade between Nigeria and CEMAC in presence of fixed exchange regime relatively to floating exchange regime. We develop a two-country Dynamic Stochastic General Equilibrium (DSGE) model with different monetary policy regimes. The model departures of the canonical model via some keys extensions, such as, net food importer, vulnerability to supply shock, large spending allocated to food consumption, the money preference and Engel’s Law in the food market. The calibration and estimations of the DSGE model would be obtain using Bayesian method by means of Monte-Carlo simulations and metropolis-hasting algorithm. The following findings could be suggested: the designed DSGE model provides a good point of departure for the examination of the effect of food prices volatility on trade between food-oriented economies in Africa facing different exchange rate regimes. Moreover, results reveal that Nigeria encompasses a huge degree of vulnerability to food prices shock than CEMAC region. Furthermore, result suggests that food prices volatility accentuate the low level of bilateral trade between Nigeria and CEMAC. In addition, results show an incomplete pass-through of exchange rate to domestic inflation in both economies. More importantly, results reveal that in the presence of adverse foreign food prices shocks, floating exchange rate regime is dominant than fixed exchange rates regime for each economy to tackle the shocks. Through welfare analysis, results confirm that, facing external food price shocks, the floating exchange rate regime is best for bilateral trade intensification between Nigeria and CEMAC. As policy implication, to enhance trade, monetary policymakers in both economies should cooperate by establishing mechanism able to offset the impact of food price volatility.