Determinants of inflation among franc zone countries in Africa
Despite belonging to a monetary union with a common currency and pooled foreign reserves, the countries of Africa's franc zone (CFA) experience substantially different inflation rates, especially in the short run. The authors develop a model of inflation differentials for the franc zone countries based on behavioral differences in fiscal policy responses to fluctuations in the price of the main export commodity. The model is basedon the fact that for primary exporters in general, and for CFA zone members in particular, the volatility of commodity prices implies a high variance in government revenues. The model identifies two effects: a monetary effect (commodity booms imply a surge in foreign reserves which, if unsterilized, is inflationary) and a fiscal effect (higher government revenues are, to varying degrees, accompanied by a marked increase in the level of spending, which is again inflationary). The fiscal relationship is the key behavioral equation of the model, as the other relationships are essentially derived from accounting identities. The authors empirically test the model for Cote d'Ivoire. It tracks quite well the inflationary cycle that Cote d'Ivoire experienced after the boom in coffee prices in 1975-76. Since the countries are in a monetary union, if some countries have expansionary fiscal policy (and thus inflation) the others must take a more contractionary fiscal stance. One issue for future research is what determines whether a member country has the freedom to follow an expansionary fiscal policy or whether it must contract because other members have already expanded. A discussion of potential games played by countries in a monetary union may shed light on these issues.
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- Shantayanan Devarajan & Jaime de Melo, 2015.
"Adjustment with a Fixed Exchange Rate: Cameroon, Côte d'Ivoire, and Senegal,"
World Scientific Book Chapters,
in: Developing Countries in the World Economy, chapter 4, pages 83-123
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- Honohan, Patrick, 1990. "Price and monetary convergence in currency unions : the Franc and Rand zones," Policy Research Working Paper Series 390, The World Bank.
- Cuddington, John, 1988. "Fiscal policy in commodity-exporting LDCs," Policy Research Working Paper Series 33, The World Bank. Full references (including those not matched with items on IDEAS)