Anchor currency and real exchange rate dynamics in the CFA Franc zone

- We study the role played by the anchor currency in the RER dynamics of CFA countries.
- There is some persistence in deviations of real exchange rates of the CFA Franc.
- The convergence of RER is effective when the euro tends to depreciate.
- This effect is mainly driven by the downward correction of the CFA Franc.
- Otherwise, real exchange rates exhibit a relatively high inertia.

Currency misalignments have been one of the focal points of interest in the literature devoted to the CFA Franc zone. Less attention has been paid, however, to the convergence process of real exchange rates towards equilibrium. In this paper, we analyze the short-run dynamics of real exchange rates of the CFA Franc zone countries and the role played by the anchor currency in their adjustment process. After controlling for the effects of the 1994 devaluation, we find the relationship between real exchange rates of the CFA Franc zone countries and of the euro to be substantial in size and subject to nonlinear effects.