A Generic Theory of Price Determination

For a long time, the general consensus regarding the causes of inflation across Sub-Saharan African countries was that inflation was mainly determined by supply side factors. This study shows that in the case of the West African Economic and Monetary Union, the driving forces of inflation emanate from both supply and demand side factors. On the supply side, rainfall, and international crude oil prices were found to be the most important supply determinants of inflation. On the demand side, the internal prices of cocoa and tobacco, the output gap of the main trading partners, and exogenous changes in the real money supply (M1), and real government spending were found to be the most important demand determinants of domestic inflation. There are 3 relevant policy implications to these findings. (1) In the short run, there is an optimal trade-off between inflation and real output that policy makers could exploit. (2) The members of the WAEMU are extremely vulnerable to supply shocks driven by large swings in commodity prices and weather shocks, the current fixed exchange rate policy does not appear to be completely isolating the countries from adverse terms of trade shocks driven by crude oil price shocks. However, the empirical estimates of the pass through of imported crude oil inflation on domestic inflation seems very slim. (3) The international prices of key cash crops remain a vital source of income for the members WAEMU.