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Do the Benefits of Exchange Rates Outweigh Their Cost? The Franc Zone in Africa

Author

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  • Devarajan, Shantayanan
  • Rodrik, Dani

Abstract

We develop a simple formal framework to clarify the trade-offs involved in the choice between a fixed and flexible exchange-rate system. We then apply the framework to the CFA Zone countries in Africa, which have maintained a fixed parity with the French franc since independence. The predominance of a few agricultural products and natural resources in their exports has meant that CFA member countries have suffered frequent shocks in their terms of trade. A flexible exchange rate might have alleviated the cost of these external shocks. On the other hand, CFA member countries have managed to maintain lower inflation levels than their neighbours. Our framework provides a way of weighing these costs and benefits. The inflation differential between CFA and non-CFA African countries has been around 14 percentage points. We attribute this differential to the standard time-consistency problem inherent in discretionary macroeconomic policy. None the less, our highly stylized calculations suggest that fixed exchange rates have been, on the whole, a bad bargain for the CFA member countries. Under `reasonable' output-inflation trade offs, these countries would have been better off having the flexibility to adjust to external shocks.

Suggested Citation

  • Devarajan, Shantayanan & Rodrik, Dani, 1991. "Do the Benefits of Exchange Rates Outweigh Their Cost? The Franc Zone in Africa," CEPR Discussion Papers 561, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:561
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    Citations

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    Cited by:

    1. Tornell, Aaron & Velasco, Andres, 2000. "Fixed versus flexible exchange rates: Which provides more fiscal discipline?," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 399-436, April.
    2. Tomell, Aaron & Velasco, Andrés, 2010. "Fiscal Discipline and the Choice of Exchange Rate Regime," IDB Publications (Working Papers) 1144, Inter-American Development Bank.
    3. Gianluigi Giorgioni, 2001. "New evidence on the output-inflation trade-off from developing economies: the case of the CFA Franc zone," Applied Economics, Taylor & Francis Journals, vol. 33(8), pages 1077-1082.
    4. Tsangarides, Charalambos G. & Qureshi, Mahvash Saeed, 2008. "Monetary Union Membership in West Africa: A Cluster Analysis," World Development, Elsevier, vol. 36(7), pages 1261-1279, July.
    5. Sebastian Edwards, 1992. "Exchange Rates as Nominal Anchors," NBER Working Papers 4246, National Bureau of Economic Research, Inc.
    6. Rama,Martin G., 1998. "Wage misalignment in CFA countries: are labor market policies to blame?," Policy Research Working Paper Series 1873, The World Bank.

    More about this item

    Keywords

    CFA Zone; Exchange Rates;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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