Testing the Purchasing Power Parity (PPP) in West and Central Africa

This paper employs various empirical methods to test the Purchasing Power Parity (PPP) hypothesis in West and Central Africa, considering countries within the WAEMU, CEMAC, CFA, and ECOWAS currency zones and four possible numeraire currencies—U.S. dollar, euro, renminbi, and the CFA franc. Using panel and single-country unit-root, cointegration, error-correction techniques, our findings indicate that the numeraire currency matters for evidence in favor of PPP. Results show slightly stronger evidence when the euro is used as the reference compared to other numeraire currencies, although results vary across different methods. Evidence for PPP is also stronger across the currency zones after the 1994 devaluation of the CFA franc, when evidence for PPP using the renminbi as reference is also stronger, suggesting an increasing importance of the renminbi for the economies in West and Central Africa. The paper documents significant differences in price dynamics for the CEMAC and the WAEMU, the two components of the CFA zone, with stronger evidence for PPP found for the WAEMU and reversal speed to PPP faster than the 2-3 years found in the literature. Results also indicate that real exchange rates of the currency zones revert to PPP mainly through adjustments of foreign prices expressed in domestic currencies—which may result from changes in nominal exchange rates of the reference currencies or foreign prices—and less so via adjustments in domestic prices.