Inter‐country trade dependence and inflation transmission mechanisms: The case of a small open African economy
International Journal of Development Issues
ISSN: 1446-8956
Article publication date: 21 September 2010
Abstract
Purpose
According to the Central Bank of Cape Verde, price stability is an important aspect when conducting its monetary policy. Given the fixed exchange rate regime towards the Portuguese Escudo/Euro and the high degree of trade inter‐dependence, this paper aims to analyse the “inflation import” phenomenon from Portugal to Cape Verde's economy from 1992 to 2008.
Design/methodology/approach
The paper takes a VECM and Granger causality approach.
Findings
The paper finds evidence in favour of the existence of a propagation mechanism, i.e., inflation transmission from Portugal to Cape Verde. The reverse conclusion is not true though. Another interesting implication from the policy‐making perspective is that Cape Verde's CPI is affected by non‐expected shocks in the short run and it takes, on average, 12 months for an adjustment towards a higher level to take place.
Practical implications
So, Portuguese inflation is an important variable to take into account when doing inflation forecasting exercises to Cape Verde's economy as well as when thinking about setting/defining exchange rate regimes. In this context, diversifying trading partners in Cape Verde is highly recommended as a way to reduce and dilute the Portuguese influence (as well as the role of external shocks) in the overall economy and price levels in Cape Verde.
Originality/value
The paper applies a well‐known economic phenomenon to the relationship between Portugal and one of its former colonies – Cape Verde. The analysis is of use to policy practioneers and to the country's Central Bank.
Keywords
Citation
Tovar Jalles, J. (2010), "Inter‐country trade dependence and inflation transmission mechanisms: The case of a small open African economy", International Journal of Development Issues, Vol. 9 No. 3, pp. 198-213. https://doi.org/10.1108/14468951011073299
Publisher
:Emerald Group Publishing Limited
Copyright © 2010, Emerald Group Publishing Limited