Oil Shocks and Macroeconomic Effects of Occasionally Binding Constraint on External Reserves of CEMAC

Abstract

This paper investigates the macroeconomic effects of Central African States Bank (BEAC) commitment to ensure its nominal anchoring when the underlying external reserves constraint occurs after an oil shock. Indeed, the current monetary agreements place external reserves at the heart of the cooperation between BEAC and the French Treasury, and their fluctuations are the main risks indicators to the durability of the cooperation between these two institutions: a system described as pegged to reserves which neither fully resembles a fixed exchange rate regime or a flexible exchange rate regime, much less an intermediate regime. To this end, there is a need to monitor their ability to cover a proportion of the central bank's liabilities in the short run by tithing the monetary conditions, in order to avoid drastic adjustment measures as devaluation. Therefore, as a result of the fall of these reserves below their long run threshold, the central bank essentially focused on their recovery. Our framework is a Markov-switching approach of the Smets and Wouters textbook model were we have modelled the dynamics of external reserves from the balance of payments identity and the simplified balance sheet of the central bank. The monetary policy rule is also augmented by the gap of reserves to their long run trend. Two scenarios are subsequently evaluated namely, a variation of the probability of occurrence of the constraint while maintaining that of leaving or, conversely, a variation of the probability of exit from the constraint by assuming that its occurrence is fixed. The results obtained show that at the approach of the constraint and in the presence of an oil shock, the behaviour of the central bank induces many undesired effects such as the fall in consumption, investment and production. Conversely, when the probability of exit from the constraint is high, the central bank adopts a somewhat passive behaviour, with a late reaction that makes the imbalances continue. Following the fact that (i) export revenue of the region are mainly composed of oil resources (84%), (ii) imports are rigid and, (iii) the oil price cannot be under control of CEMAC countries for competitiveness purpose, the paper highlights the need for permanent monetary discipline alongside economic diversification.