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Africa: Inside the Triangle of Devaluation, Inflation and Stagnation (article)

Listed author(s):
  • Kalonga Stambuli

    (Surrey Institute of Global Economics Research)

The author argues that a policy of devaluation imposed on African economies in compliance with real exchange rate rules contradicts the inflation objectives of fiscal stabilisation because by devaluing a currency at every instance of inflation, it implies that the exchange rate is indexed to the domestic price level via the balance of payments and money supply. Given that one characteristic of African economies is that government is the largest consumer of foreign exchange, in the context of debt service payments, exchange rate depreciation magnifies the public sector net cash requirement and leads to a faster rate of monetary growth, thus resulting in further cyclic inflation. The author also argues that the other effect of devaluation is also to compromise bank balance sheets and lead to contractions in bank lending capacities, which also affect the real economy. This is on account of the fact that African banks hold open speculative positions in foreign exchange, which increase vulnerability of the entire financial system. The author supports the effectiveness of devaluation in changing the vector of relative prices via the price mechanism and therefore operating as an expenditure-switching device, but the fact that it also serves as a ‘conveyor belt’ transmitting costs into production structures and driving inflation quicker than the acclaimed price improvements undermines such merits.

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Paper provided by EconWPA in its series International Trade with number 0211002.

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Date of creation: 09 Nov 2002
Handle: RePEc:wpa:wuwpit:0211002
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