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

João Tovar Jalles (Faculty of Economics and Politics, University of Cambridge, Cambridge, UK)

International Journal of Development Issues

ISSN: 1446-8956

Article publication date: 21 September 2010

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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

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Emerald Group Publishing Limited

Copyright © 2010, Emerald Group Publishing Limited