On Exchange Rate Policy Independence: Experiences from West Africa

Abstract

<jats:title>Abstract</jats:title><jats:p>Monetary policy independence has been a key topic in the quest for a long-term sustainable macroeconomic environment. Much of this focus has been on independence with regard to interest rate setting, liquidity management, and price stability. In this article, I argue that in developing countries, especially in mono-export economies, exchange rate problems have the potential to be a source of macroeconomic instability, but exchange rate policy has not received the same protections from politics. I show that in a sample of countries in West Africa, exchange rate policy has remained firmly in the hands of government, with bouts of overvaluations common. I show that these periods of currency overvaluations are associated with slower growth. I argue that legislative limits on exchange rate overvaluations based on some objective measure might provide policy makers with the leeway to prevent suboptimal exchange policy driven by political sentiment.</jats:p>