Do the Benefits of Fixed Exchange Rates Outweigh Their Costs? The Franc Zone in Africa

We develop a simple formal framework to clarify the trade-offs involved in the choice between a fixed and flexible exchange-rate system. We then apply the framework to the CFA Zone countries in Africa, which have maintained a fixed parity with the French Franc since independence. Thanks to the predominance of a few agricultural products and natural resources in their exports, CFA member countries have suffered frequent shocks in their terms of trade. A flexible exchange rate could have possibly alleviated the costs of these external shocks. On the other hand, CFA member countries have managed to maintain lower inflation levels than their neighbors. Our framework provides a way of weighing these costs and benefits. The inflation differential between CFA and non-CFA African countries has been around 14 percentage points. We attribute this differential to the standard time-consistency problem inherent in discretionary macroeconomic policy. Nonetheless, our highly stylized calculations suggest that fixed exchange rates have been, on the whole, a bad bargain for the CFA member countries. Under reasonable output-inflation tradeoffs, the output costs of maintaining a fixed exchange rate have outweighed the benefits of lower inflation.

Africa: Leveraging the Crisis into a Development Takeoff

Africa’s precrisis growth and poverty reduction was the result of increased external resources, a buoyant global economy and—crucially—improved economic policies. Although it is still the world’s poorest region, the prospects for resuming growth are good. Additional resources and further policy reforms could launch the continent on a path of sustained growth and poverty reduction.Africa, Crisis, development, growth, poverty reduction, reforms, policies, sub-Saharan, recovery, developing countries

Do the benefits of fixed exchange rates outweigh their costs? The Franc Zone in Africa

The authors develop a simple, formal framework for clarifying the tradeoffs involved in choosing between a fixed and flexible exchange rate system. They apply this framework to the countries of Africa's CFA Zone, which have maintained fixed parity with the French franc since independence. Because a few agricultural products and natural resources dominate their exports, member countries of Africa's CFA Zone have suffered frequent shocks in terms of trade. A flexible exchange rate could possibly have alleviated the costs of these external shocks. On the other hand, CFA member countries have managed to maintain lower inflation levels than their neighbors. The fixed exchange rate of the CFA Zone acts as a credible committment. The government"ties its own hands"so that it will not be tempted to use the exchange rate, thereby eliciting lower wage and price increases from the private sector. Weighing this benefit against the costs of nonadjustment to external shocks, the authors conclude that fixed exchange rates have been a bad bargain for the CFA member countries. These countries would have been better off having the ability to adjust to external shocks.Environmental Economics&Policies,Macroeconomic Management,Fiscal&Monetary Policy,Economic Stabilization,Economic Theory&Research

The implications of foreign aid fungibility for development assistance

A foreign aid or foreign lending policy that focuses exclusively on project financing may have unintended consequences, report the authors. New research shows that aid intended for crucial social and economic sectors often merely substitutes for spending that recipient governments would have undertaken anyway and the funds that are thereby freed up are spent for other purposes. If the aid funds something that would have been done anyway, traditional ways of evaluating the aid's effectiveness are not really accurate. Ifaid funds are fungible and the recipient's public spending program is unsatisfactory, project lending may not be cost-effective. If the recipient's public spending program is satisfactory, perhaps the donor should finance a portion of it instead of financing individual projects. One solution to the problem of fungibility, then, is that donors could tie assistance to an overall public spending program (in the recipient country) that provides adequate resources to crucial sectors. To make this kind of reform operational, the authors propose a new lending instrument: a public expenditure reform loan (PERL). A PERL would tie an institution's lending strategy to the recipient country's achievement of mutually agreed-upon development goals. Everyone agrees that better donor coordination is needed, but it has been difficult to achieve because some donors tend to prefer projects (usually with the national flag flying over them). By agreeing on a public expenditure program and financing a portion of it, the World Bank credibly ask other donors to do the same.Payment Systems&Infrastructure,Development Economics&Aid Effectiveness,Gender and Development,Decentralization,Economic Adjustment and Lending,Development Economics&Aid Effectiveness,Poverty Assessment,National Governance,Economic Adjustment and Lending,Public Sector Economics&Finance

The combined incidence of taxes and public expenditures in the Philippines

Incidence studies of fiscal policy in developing countries typically examine either the distribution of tax burdens or the incidence of public expenditures. But the central issue for policymakers is the combined or net incidence of fiscal activities. One reason that combined incidence studies are so rare is that they require detailed data on both taxation and public spending. The authors show that the net incidence of fiscal policy in a country with average data - the Philippines - can be estimated using a variety of data sources and tools, using simplifying assumptions. For 20 years, the Philippine economy has experienced a series of balance of payments crises triggered by fiscal crises. It has had an unsatisfactory record of poverty alleviation. The authors examine net fiscal incidence to find out how poverty will be affected by the rise in taxes and the cut in spending. They found that: 1) the incidence pattern of taxes is basically neutral. Contrary to expectations, indirect taxes are only slightly regressive; and 2) it is the pattern of expenditures that drives the combined incidence, which is progressive.Public Sector Economics&Finance,Environmental Economics&Policies,Health Systems Development&Reform,Economic Theory&Research,Health Economics&Finance,Environmental Economics&Policies,Public Sector Economics&Finance,Economic Theory&Research,Health Economics&Finance,Banks&Banking Reform

Membership in the CFA zone : Odyssean journey or Trojan horse?

For most of the 13 African members of the CFA Franc Zone, the 1980s have been a decade of slow or negative growth in per capita gross domestic product, worsening balance of payments, debt crises, financial crises declining competitiveness, and an apparent failure to adjust to the changed environment they inherited from the 1970s. This paper reassesses the costs and benefits of membership in the CFA Franc Zone in light of its members'poor performance in the 1980s. The assessment is based on comparisons of the members'performance indicators with indicators for comparator groups: other countries in sub-Saharan Africa, other low- and middle-income countries, and other exporters of fuel and primary goods. Performance indicators for members of the CFA Zone deteriorated more than indicators for other groups. Growth and investment rates fell more for CFA countries. This decline is attributed to the CFA members'declining competitiveness as other countries undertook adjustment programs that emphasized depreciation of the real exchange rate. The burden of adjustment appears to have fallen disproportionately on reduced spending, particularly reduced investment.Achieving Shared Growth,Environmental Economics&Policies,Macroeconomic Management,Economic Theory&Research,Economic Stabilization

Preserving the CFA Zone : macroeconomic coordination after the devaluation

On January 12, 1994, the CFA franc - the currency of the thirteen African states of the CFA Franc Zone - was devalued 50 percent. The event had been expected for some time, but the magnitude and one-shot nature of the devaluation posed problems for members of the zone's two monetary unions. The authors conclude the following about what has happened: (a) Inflation has been substantially lower than in most developing countries, but the mechanisms of macroeconomic discipline have been inadequate, especially for fiscal discipline. The recent crisis has its roots in failures of fiscal discipline as much as in the constraints on restoring competitiveness because of the fixed parity. (b) The transmission of inflation across states has not been a problem in the past, but could be more of one in the future with the common nominal shock, the temporary loss of the French franc as an anchor, and the rising importance of supranational quasi-fiscal deficit. (c) For macroeconomic coordination, it is appropriate to continue relying on a mixture of rules and discretion and not on the market, at least in the medium term. The 20 percent rule has been inadequate in the past and should be supplemented by annual targets for fiscal performance (including deficit of Gross Domestic Product ceilings, a primary surplus requirement, and no borrowing to finance current spending). (d) Sanction on errant states should be imposed through reduced access to borrowing. Central Bank and at least some foreign borrowing should be conditional on meeting the annually agreed upon targets. (e) The Central Banks'ability to impose these sanctions should be strengthened, possibly by channeling a portion of foreign credit going to the zone through the Central Banks. Technical assistance may also help. (f) Insulation can be affected by ensuring that quasi-fiscal deficits are explicitly financed by country budgets, reversing the recent trend to make them international by having the BCEAO finance part of the national banks'portfolio problems. (g) The current size of the quasi-fiscal deficit (and hence the future earnings position) of the two Central Banks should be assessed early and put on the budgets of the various national governments, with allocation based on the original source of the problem. If necessary, additional measures should be undertaken to secure a strong capital base for the Central Banks. (h) Exit from the zone is best discouraged by securing the zone's credibility. It should also be clear that those that exit because of macroeconomic problems will not have easier access to international sources of finance.Banks&Banking Reform,Economic Stabilization,Financial Intermediation,Economic Theory&Research,Public Sector Economics&Finance

Civil Society, Public Action and Accountability in Africa

This paper examines the potential role of civil society action in increasing state accountability for development in Sub-Saharan Africa. It further develops the analytical framework of the World Development Report 2004 on accountability relationships, to emphasize the underlying political economy drivers of accountability and implications for how civil society is constituted and functions. It argues on this basis that the most important domain for improving accountability is through the political relations between citizens, civil society, and state leadership. The evidence broadly suggests that when higher-level political leadership provides sufficient or appropriate powers for citizen participation in holding within-state agencies or frontline providers accountable, there is frequently positive impact on outcomes. However, the big question remaining for such types of interventions is how to improve the incentives of higher-level leadership to pursue appropriate policy design and implementation. The paper argues that there is substantial scope for greater efforts in this domain, including through the support of external aid agencies. Such efforts and support should, however, build on existing political and civil society structures (rather than transplanting "best practice" initiatives from elsewhere), and be structured for careful monitoring and assessment of impact.