Inter-country trade dependence and inflation transmission mechanisms: the case of a small open African economy

Joao Jalles

Research output: Contribution to journalArticle

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.
Original languageEnglish
Pages (from-to)198-213
Number of pages17
JournalInternational Journal of Development Issues
Volume9
Issue number3
DOIs
Publication statusPublished - 2010

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