Woodford Goes to Africa

Abstract

This paper analyses the effects of inflation shocks, demands shocks, and aid shocks on low-income, quasi-emerging-market economies, and discusses how monetary policy can be used to manage these effects. We make use of a model developed for such economies by Adam et al. (2007). We examine the effects of four things which this model features, which we take to be typical of such economies. These are: the existance of a tradeables / non-tradeables production structure, the fact that international capital movements are - at least initially - confined to the effects of currency substitution of monetary policy, and the pursuit, in some countries, of a fixed exchange rate. We then modify the model to examine the effect on such economies of three major changes, changes which we make to be part of the transition by such economies towards more fully-interest-parity comes to hold, a move to floating exchange rates, and the replacement of fixed stocks of financial aggregates by the pursuit of a Taylor rule in the conduct of monetary policy.

Keywords: currency substitution, emerging market macroeconomics, interactions between fiscal and monetary policy, Taylor rule

JEL Classification: E5, E61, O11