Abstract

The main argument in favor of a fixed exchange rate regime (ERR) is its ability to maintain lower inflation in the long run compared to a flexible ERR (Mundell, 1963; Fleming, 1962). This paper empirically tests whether the fixed ERR of the CFA franc currency union provides lower inflation to its members relative to inflation in the non-CFA Sub-Saharan African (SSA) countries. SSA countries are grouped by their exchange rate regimes using the International Monetary Fund (IMFs) de facto classification to analyze the dynamics of inflation within the groups of fixed ERR in comparison to the non-fixed ERR groups. The empirical results support the inflation-growth trade-off in the CFA zones. While the CFA countries experience a relatively lower inflation in the short and long run, they suffer from a pronounced output loss relative to all other non-CFA countries in general and relative to the non-CFA countries with pegged ERR in particular. As individuals’ welfare depends on the change in their consumption of goods and services rather than the growth level of inflation (Aiyagari, 1990), the finding of this paper suggests that the CFA countries’ fixed ERR compounded with an alignment to a common currency undermines their economic performances.

Key words: Inflation, exchange rate regimes, CFA franc currency union, Sub-Saharan Africa.