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Do the benefits of fixed exchange rates outweigh their costs? The Franc Zone in Africa

Author

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  • Devarajan, Shantayanan
  • Rodrik, Dani

Abstract

The authors develop a simple, formal framework for clarifying the tradeoffs involved in choosing between a fixed and flexible exchange rate system. They apply this framework to the countries of Africa's CFA Zone, which have maintained fixed parity with the French franc since independence. Because a few agricultural products and natural resources dominate their exports, member countries of Africa's CFA Zone have suffered frequent shocks in terms of trade. A flexible exchange rate could possibly have alleviated the costs of these external shocks. On the other hand, CFA member countries have managed to maintain lower inflation levels than their neighbors. The fixed exchange rate of the CFA Zone acts as a credible committment. The government"ties its own hands"so that it will not be tempted to use the exchange rate, thereby eliciting lower wage and price increases from the private sector. Weighing this benefit against the costs of nonadjustment to external shocks, the authors conclude that fixed exchange rates have been a bad bargain for the CFA member countries. These countries would have been better off having the ability to adjust to external shocks.

Suggested Citation

  • Devarajan, Shantayanan & Rodrik, Dani, 1991. "Do the benefits of fixed exchange rates outweigh their costs? The Franc Zone in Africa," Policy Research Working Paper Series 777, The World Bank.
  • Handle: RePEc:wbk:wbrwps:777
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    References listed on IDEAS

    as
    1. Boyer, Russell S, 1978. "Optimal Foreign Exchange Market Intervention," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1045-1055, December.
    2. Guillaumont, Patrick & Guillaumont, Sylviane & Plane, Patrick, 1988. "Participating in African monetary unions: An alternative evaluation," World Development, Elsevier, vol. 16(5), pages 569-576, May.
    3. Devarajan, Shantayanan & de Melo, Jaime, 1990. "Membership in the CFA zone : Odyssean journey or Trojan horse?," Policy Research Working Paper Series 482, The World Bank.
    4. Corden, W. Max, 1990. "Exchange rate policy in developing countries," Policy Research Working Paper Series 412, The World Bank.
    5. Peter J Montiel & Bijan B. Aghevli & Mohsin S. Khan, 1991. "Exchange Rate Policy in Developing Countries; Some Analytical Issues," IMF Occasional Papers 78, International Monetary Fund.
    6. Devarajan, Shantayanan & de Melo, Jaime, 1987. "Evaluating participation in African monetary unions: A statistical analysis of the CFA Zones," World Development, Elsevier, vol. 15(4), pages 483-496, April.
    7. Fischer, Stanley, 1990. "Rules versus discretion in monetary policy," Handbook of Monetary Economics,in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 21, pages 1155-1184 Elsevier.
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