Inflation Dynamics of Franc-Zone Countries Determinants, Co-movements and Spatial Interactions

Abstract

This paper shows the uneven role played in the inflation dynamics of African franc zone countries by their integration in a regional monetary union. We obtain three main results sharply contrasting the central- (CEMAC) and west-African (WAEMU) regions. First, differences in the structure of economies and national fiscal stances play a similar role in both unions and appear as potential sources of inflation differentials. Second, even though co-movements are the principal drivers of inflation dynamics in both subregions, global factors dominate regional ones in WAEMU while both play an equal role in CEMAC. Thirdly, spatial interactions are unimportant in CEMAC due to little intra-zone trade, but take an asymmetric form in WAEMU due to the large size of Ivory Coast and Senegal.

Appendices

Appendix 1

Table 7 Country sample

Appendix 2 Main Determinants of Inflation Differentials

In order to identify some determinants of inflation differentials for each of the two subregions, we follow the same approach as Honohan and Lane (2003), thereafter HL, modelling inflation differentials as follows:

$$ {\pi}_{it}-{\pi}_t^E=\beta \left({Z}_{it}-{Z}_t^E\right)+\delta \left(\left[{FP}_{it-1}-{FP}_{it-1}^{\ast}\right]\right.-\left[{FP}_{t-1}^E-{FP}_{it-1}^{E\ast}\right]\left(\right)+{\varepsilon}_{it} $$

(5)

where π _it , ${\pi}_t^E$ are the annual national and regional inflation rates respectively; Z _it , ${Z}_t^E$ are national and regional (control) variables that exert a short-term influence on the inflation rate; FP _it , ${FP}_t^E$, are the national and regional Purchasing Power Parity (PPP) factors and ${FP}_t^{\ast }$, ${FP}_t^{E\ast }$, are the national and regional long-run equilibrium price levels. Assuming that the countries share a common long-run price level, the above equation can be simplified to:

$$ {\pi}_{it}-{\pi}_t^E=\beta \left({Z}_{it}-{Z}_t^E\right)+\delta \left(\left[{FP}_{it-1}-{FP}_{t-1}^E\right]+{\varepsilon}_{it}\right. $$

(6)

Taking into account that each subregion is characterized by the free flows of goods, people and capital, we assume that the long run prices are the same across countries and focus on the reduced form of eq. 6 which can be written as follows:

$$ {\pi}_{it}={\alpha}_t+\beta {Z}_{it}+\delta {FP}_{it-1}+{\varepsilon}_{it} $$

(7)

where α _t are time-dummies that capture common movements in inflation and explanatory variables.

This means that the regressions are explaining inflation differentials in terms of idiosyncratic national changes in the determinants. Vector Z consists of several key variables, namely the unemployment rate (representing labor market institutions), economic sectors (production structure), the degree of openness (share of the average of exports and imports in output), exchange rate (external effect) and fiscal balance. Another prominent variable is the lagged Purchasing Power Parity factor (convergence conditioning variable). Theoretically, if there is convergence in inflation rates the estimated values of δ will be negative. This would imply that inflation of a region with an initially relatively high inflation rate would increase more slowly (or decrease faster) in the subsequent period than that of a region with an initially relatively low inflation rate.

Then this model’s specification can be written as:

$$ {\displaystyle \begin{array}{l}{\pi}_{it}={\alpha}_t+{a}_0{unp}_t+\delta {FP}_{it-1}+{a}_1{ouv}_t\ast \varDelta {tcen}_t+{a}_2{agr}_t+{a}_3{manu}_t+{a}_4{serv}_t+{a}_5{gap}_{it}\\ {}\kern1.75em +{a}_6{prod}_t+{a}_7{sb}_t+{u}_{it}\end{array}} $$

The potentials determinants of inflation differentials are the unemployment rate (ump _it ), Purchasing Power Parity (fp _it ), the degree of openness (ouv _it ), nominal exchange rate changes (Δtcen _it ), the GDP share of the primary sector (agr _it ), the GDP share of manufacturing (manu _it ), the output gap (gap), total factor productivity growth (Δprod _it ) and the fiscal balance (sb _it ). Data are annual and cover the sample 1995–2015. Fiscal balances are extracted from zone franc reports. Purchasing Power Parity factors, the unemployment rate, imports and exports, output and the production structure come from the World Bank’s World Development Indicators (WDI) data base, while nominal effective exchange rates are obtained from the IMF (IFS) and total factor productivity from the The Conference Board Total Economy Database and the Federal Reserve Economic Data.

Table 8 Panel data unit root tests (Levin et al. 2002)

Table 9 Estimates of the inflation differential model (Only significant variables are kept)

Table 10 Pearson Correlation matrix

Appendix 3

Table 11 Eigenvalue and variance explained by the eigenvectors in each subperiod

Appendix 4

Table 12 Correlation between global factors and inflation for the main groups of countries, oil and food products

Appendix 5

Table 13 Results of estimations of country models