Publication: Navigating post-Covid-19 economic recovery in WAEMU: A DSGE approach
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Abstract
This paper evaluates the effectiveness of economic policies implemented by fiscal and monetary authorities against the Covid-19 pandemic in the West African Economic and Monetary Union (WAEMU). To that end, we employ a medium-scale DSGE model that regards WAEMU as a closed system, made up of a continuum of small open economies. Our simulations reveal that, while an ample battery of fiscal and monetary measures was deployed to counter the challenges posed by Covid-19 and support economic recovery, fiscal policy interventions proved more effective in the short run. Fiscal measures mitigated the pandemic’s economic fallout across all households, providing immediate relief and promoting a swift rebound.
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This paper focuses on the effectiveness of fiscal and monetary policies implemented within the WAEMU context during the Covid-19 pandemic. Specifically, the article examines the effects of fiscal and monetary policies individually considered and their crucial role in facilitating economic recovery within the WAEMU. A DSGE model with stochastic simulations is constructed. The Covid-19 shock is presented as an autoregressive process that directly affects labor supply, aggregate demand as well as household consumption, and the external bloc like exports, global interest rates, and inflation.
Governments in the WAEMU area have taken several steps toward allocating expenditures to address the economic fallout from the pandemic. These efforts were complemented by supportive monetary policy whenever anti-inflationary pressures permitted. We find that, while both types of measures may have played a role in mitigating the negative effects over an extended horizon, fiscal policy interventions have proven to be much more effective in alleviating the short-run impact of the pandemic in WAEMU, especially for non-Ricardian households. It is worth pointing out, though, that when viewed proportionally, Ricardian households may have ended up gaining more from the expansionary fiscal policy.
Specifically, on the one hand, fiscal measures, such as government spending and the issuance of securities, have a positive effect on production, consumption, and the exchange rate. Tax reductions or exemptions have been found to have a limited positive impact on consumption and production, primarily due to the decreased purchasing power of workers resulting from the inflation spike that the combination of the supply-side constraints and lower taxation generates. However, it should be noted that tax reductions particularly targeted at wages have demonstrated a positive, although quite short-lived, effect on Ricardian household consumption.
On the other hand, reductions in interest rates, reserve requirements, and collateral do not seem to have a positive effect on consumption. The likely causes may lie in the higher inflation and the exchange rate depreciation that the monetary easing induces on impact. These side effects of the looser monetary stance also trigger a swift policy reversal by the central bank, as dictated by the monetary rule. This monetary tightening brings down the probability of loan repayment and causes a deep output fall. On the positive side, the monetary stimulus only fosters output from the sixth quarter onwards.
The latter has important public policy implications. The study emphasizes the superiority of fiscal policy over monetary policy in times of crises such as pandemics. Policymakers should consider targeted fiscal measures that directly support vulnerable households, as these can have a significant positive impact on household consumption, aggregate demand, and overall economic recovery.
The DSGE model used in this research is a simplified representation of the WAEMU economy, and it may not capture all the complexities and nuances of the real-world economy. Therefore, the findings of this research should be interpreted with caution. The Covid-19 shock is presented as an auto-regressive AR(1) process in this research, which may not fully capture the complexity and uncertainty of the pandemic’s impact on the economy. Future research could explore the impact of different types of fiscal policy interventions on economic recovery in the WAEMU. For example, it could investigate the effectiveness of a broader range of targeted fiscal policies, such as subsidies or tax incentives, in supporting specific sectors or groups of households. Additionally, it could examine the effectiveness of government interventions amidst political or ethnic conflicts, a problem several member countries of the African union are prone to. In summary, employing larger-scale models incorporating additional variables and factors could better capture the complexity and uncertainty of the Covid-19 pandemic and its impact on the WAEMU economy.
Bibliographic reference
Economic Analysis and Policy Volume 84, December 2024, Pages 707-724