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Open Access Knowledge and Scholarship

Date of Award

12-2018

Culminating Project Type

Thesis

Degree Name

Applied Economics: M.S.

Department

Economics

College

School of Public Affairs

First Advisor

Artatrana Ratha

Second Advisor

Nimantha Manamperi

Third Advisor

Lynn A. Collen

Creative Commons License

Creative Commons License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

Keywords and Subject Headings

CFA franc, Real effective exchange rate, Trade balance, Competitiveness.

Abstract

Created out of the need to integrate France with its former colonies, the CFA Franc was launched in 1945 and pegged to the French Franc until the arrival of the euro when the peg was changed to 655.957 CFA per euro. While a fixed-exchange-rate, a priori, helps mitigate exchange rate risks and thus, promotes trade and investment, economic growth in the region remains sluggish and uneven, at least partly due to a lack of autonomous, country-specific monetary policy confronting the asynchronous business cycles among the member nations. Also, currency devaluation is not a policy option that could help correct the chronic trade deficits in the zone. Moreover, not only the EU’s share in the region’s total trade has declined, there is a potential currency misalignment where the real exchange rate based on the current peg deviates from where it would be, based on a country’s economic fundamentals, the Equilibrium Exchange Rate. Whether such misalignment might have contributed to the trade deficits in the CFA zone is an empirical question that this panel study investigates using two different trade balance equations, one using the real effective exchange rate (REER) and the other using the equilibrium real effective exchange rate (EREER) on annual data over 1985-2015. We find that REER does not carry the theoretically postulated sign in the estimated trade balance equation but the equilibrium one (EREER) does. Moreover, when the EREER is used, trade balance seems to be more elastic, especially during the post devaluation era (1995-2015), when we are able to recover the expected sign for REER. Considering the misalignment between REER and EREER, it appears that being anchored to a foreign currency, CFA franc likely has not helped the CFA countries improve their trade competitiveness. Having their own currency, and control over monetary and exchange rate policy, would enable them to deal better with country specific shocks and boost trade competitiveness. However, this would have to be preceded by the strengthening of the political institutions, enforcement of stricter fiscal discipline and independent monetary policy.

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