Desalignment of exchange rate and reduction of inflation in franc zone

Abstract

The purpose of this article is to study the potential repercussions of overvaluation or undervaluation, also called « misalignment » of the exchange rate on the level of inflation in the franc zone. First of all, it is clear that since the devaluation of 1994, prices have only increased exponentially; particularly those essential products. The question that comes to mind is whether the policy adopted is not most appropriate for the area or the devaluation percentage is low. To answer these questions, we used dynamic panel relating to ours ample including 14 countries in the franc zone and using the generalized moment estimation method. To do this, we used the regression model with an independent equation. The test that allowed us to estimate our hypothesis is the Arellano and Bond test (1998). At the end of this test, it appears that the undervaluation negatively influences the level of inflation in the franc zone. In other words, when the exchange rate depreciates, inflation increases. This could be one of the consequences to the “net importer” status of the countries in the area because undervaluation generates imported inflation. This result is all more plausible as the facts bear it out. For example inflation in Cameroon increased from 2% in 2020 to 6.6% in 2023. It would then be beneficial for these countries to put in place measures to support the undervaluation policy in the order to reduce the import and enjoy the benefits of this policy.

Keywords: exchange rate regime, inflation, exchange rate, monetary system, misalignment.

Classification JEL: F13, F2, F4

Paper type: Empirical research