## sipea2023038

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---

### I. Recent Developments in the WAEMU Inflation
- Headline inflation:
  - Rose sharply beginning in 2020 after recording negative rates throughout 2019, peaking in August at 8.8 percent and slowing to 8.0 percent in November 2022.
  - Increasing heterogeneity across member countries: in November 2022, Burkina Faso inflation was 12.2 percent and Benin was 3.2 percent.
- Historical component contributions (January 1999–October 2022):
  - Food contributions averaged 1.2 percentage points against a 2.3 percent average inflation rate for the period.
  - Housing and transport jointly contributed approximately 0.5 percentage points to headline inflation.
  - The remaining nine components contributed 0.6 percentage points jointly.
- Consumption-basket weights in WAEMU:
  - Food weight: 42 percent.
  - Housing weight (including energy items): 11 percent.
  - Transportation weight (including energy items): 9 percent.
- Crisis episode (global financial crisis):
  - Headline inflation rose from about 2 percent to over 10 percent then returned to target within ~two years; fluctuation driven mainly by food prices—excluding food, inflation stayed close to target.
- Short-term (November 2022) component contributions to inflation:
  - Food: 5.3 percentage points.
  - Housing: 0.7 percentage points.
  - Transportation: 0.6 percentage points.
- Historical peak (August 2008) component contributions:
  - Food: 7.4 percentage points.
  - Housing: 0.5 percentage points.
  - Transportation: 0.75 percentage points.
- Historical averages:
  - Food: 1.2 percentage points.
  - Housing: 0.2 percentage points.
  - Transportation: 0.3 percentage points.
- Country-level patterns:
  - Food contributions particularly relevant in Burkina Faso.
  - Togo and Côte d'Ivoire show more diversified contributions across inflation components.
- International food price pass-through:
  - Domestic food prices tend to follow international prices closely; IMF WEO forecasts expect international food price inflation to decline significantly, suggesting a conceivable quick reversal of regional food inflation as in past episodes.

### II. Sectoral Dynamics and Inflation Contagion
- Non-food inflation dynamics:
  - Non-food inflation rarely exceeded the target over the past two decades.
  - Over the past year-and-a-half, non-food inflation increased from about 0.5 percent to about 2.7 percent, driven mainly by housing, transportation (both driven mainly by higher energy prices), and “other” items (services).
  - Contribution from energy prices to headline inflation has remained muted despite large increases in international oil prices due to domestic mitigating policies in most countries.
- Food inflation drivers (Jan 2021–Jun 2022 notable increases):
  - Bread: -0.4 to 15.9 percent.
  - Cooking oil: 4.5 to 19.4 percent.
  - Flour and groats: 0.7 to 14.8 percent.
- Official core inflation:
  - Excludes “fresh” food and energy, but keeps several non-perishable and other food items.
  - Contribution from food inflation to headline rose from 1.4 percent in January 2021 to 5.3 percent in November 2022.
  - Official core inflation breached BCEAO’s upper target limit in August 2021, reaching 5.3 percent in November 2022.
  - Inclusion of many food components in official core weakens its adequacy to capture underlying inflation trend.
- Persistence index (AR(1) with a 48-month rolling window):
  - Increased from 0.10 in January 2021 to 0.55 in September 2022.
  - Historical average: 0.2.
  - Higher persistence implies stronger influence of past inflation on expectations and price formation, complicating monetary control.
  - Non-food inflation persistence: was negative in past few years but recently moved toward zero from negative as non-food inflation averaged a positive number.
- Inflation expectations (BCEAO survey of companies' leaders):
  - Share expecting inflation above 3 percent in a one-year horizon: increased from 11.9 percent in December 2021 to 28.5 percent in September 2022.
  - Share expecting one-year inflation between 1 percent and 3 percent: decreased from 81.1 percent to 66.8 percent over the same period.
- Diffusion index (126 headline items):
  - Share with inflation rates above 2 percent surpassed 50 percent in March 2022 and reached 68 percent in September 2022 (previously around 30 percent since 2019).
  - Diffusion index above 3 percent has also been rising since 2021 and is now above 50 percent.
  - Excluding food, housing and transport, highest increases are in beverages & tobacco, clothing, furnishing, and “others” (services) — indicating rising potential pass-through from food/energy to other prices.
  - At a 3 percent threshold, contagion evidence prevails primarily in beverages & tobacco and furnishing; hotels and restaurants are very volatile (3 items) and closely related to food and energy.
- Distributional changes:
  - Sep 2020–Sep 2022 histogram: mean inflation higher, distribution wider and shifted to the right—greater dispersion toward higher inflation—driven mainly by food, housing, and transport; other categories showed more contained changes.
- Non-food and service item surges:
  - Items outside food and energy with major price increases include services such as hairdresser, insurance, maintenance and repair for housing, clothing.
  - Many of these items were under deflation or near 0 percent one year earlier, suggesting supply-demand imbalances and rebound after the pandemic; sustained surges would indicate second-round effects.
- Data limitations:
  - Very detailed breakdown of sectoral inflation data is not available for recent months.
  - Scarce availability of timely wage data and high informality impede analysis of second-round mechanisms, wage-price pass-through, and wage-price spiral assessment.

### III. Going Forward: Inflation Forecasts and Monetary Policy Implications
- BCEAO target:
  - Forward-looking, 2 percent year-over-year inflation rate with symmetrical ceiling and floor of 1 percentage point within a 24-month horizon (i.e., target band 1–3 percent).
- Forecasting methodologies:
  - SARIMAX (Seasonal Auto-Regressive Integrated Moving Average with exogenous factors).
  - AFRMOD-FSGM (African Module of the Flexible System of Global Models) based on Andrle et al. (2015) applied to WAEMU.
- SARIMAX specification and data:
  - Dependent variable: WAEMU headline inflation (year-over-year quarterly frequency).
  - Exogenous variables: international fuel and foods prices and the nominal effective exchange rate (IMF WEO database).
  - Estimation period: 1997Q1–2022Q2.
  - Forecast period: 2022Q3–2024Q4.
  - Assumption: recent depreciation of the nominal effective exchange rate abates so yearly change converges to zero during forecast period.
  - Limitation: econometric exercise cannot explore alternative monetary policy responses beyond average historical behavior embodied in estimated coefficients.
- AFRMOD-FSGM features:
  - Real GDP determined short-run by demand components, long-run by potential output.
  - Fiscal policy stabilizes debt-to-GDP in long run and responds to output gap in short run.
  - Monetary policy via interest rate reaction function (inflation-forecast based rule).
  - Two exchange rate regime scenarios presented due to capital controls and some monetary independence: fixed exchange rate with small addition of country risk premium; managed float.
  - Three commodities in model: oil, metals, and food; annual frequency; sticky goods prices.
- Model simulation outcomes:
  - SARIMAX and AFRMOD-based forecasts suggest inflation expected to decrease to 1¾ percent by 2024Q4 based on WEO GAS projections of lower fuel and food prices and minimal exchange rate pressure.
  - SARIMAX result: by end-2024 inflation expected to reach 1¾ percentage points (within target range), implying no monetary policy change required based on this calculation.
- AFRMOD shock scenarios:
  - Shock 1: Increase in global food prices of 30 percent in 2022 (annual calibration).
    - Result: short-lived headline inflation reaction in WAEMU, increasing by 5 percentage points in 2022 and fading in subsequent years.
    - Effect on traditional core inflation (excluding food and energy): negligible.
  - Shock 2: Increases in Euro area and US inflation path (core inflation path obtained from WEO; inflation shock = WEO path minus 2 percent steady-state core for euro and US).
    - Result: headline inflation in WAEMU gradually increases by approximately 1 percentage point and slowly decreases by half percentage point by end-2026; small impact cushioned by a moderate central bank monetary policy reaction.
- Confidence intervals (AFRMOD forecast charts):
  - Dark shaded purple area: 50% confidence interval.
  - Light shaded purple area: 90% confidence interval.

### IV. Other Factors Relevant for Inflation Developments and Desirable Monetary Response
- Structural and supply-side constraints exacerbating food inflation:
  - Climate shocks.
  - Security issues.
  - Health crises.
  - Constraints on local production contribute to vulnerability to global food price shocks.
- Policy containment of energy price pass-through:
  - Domestic policies in most countries have muted the contribution of international oil price increases to headline inflation.
- Monetary policy implications:
  - Given forecasts (SARIMAX and AFRMOD) pointing to inflation around 1¾ percent by 2024Q4, current stance does not call for a change in monetary policy per SARIMAX.
  - AFRMOD scenarios suggest that large global food shocks can cause substantial but short-lived headline inflation increases, while global core inflation increases could transmit modestly into WAEMU headline inflation; a moderate monetary policy reaction can cushion these effects.
- Monitoring priorities for policy:
  - Track international food and fuel price paths (WEO projections are key inputs).
  - Monitor persistence index and diffusion index developments to assess entrenchment and spread of inflation across items.
  - Improve data availability on wages and labor markets to better assess second-round effects, wage-price pass-through, and inform monetary policy responses.

### Model limitations and implications (Section 2)
- SARIMAX model:
  - Described as "well-grounded in the key drivers of inflation" but "remains a simple benchmark" and "does not encompass a broad set of fundamentals in a general equilibrium setting."
  - If "persistent and second round effects are stronger than over the historical sample over which the SARIMAX model was estimated, the model would not be able to capture these effects."
  - For a pure, short-lived global food price shock the model indicates:
    - Headline inflation: short-lived reaction.
    - Core inflation: very limited reaction.
    - Policy implication: "the central bank does not need to react" for a "pure, short-lived supply shock with no further inflation contagion across sectors nor second-round effects."

### Simulation results for global inflation shocks (Section 2)
- Positive shock to Euro area and US inflation paths:
  - Produces "a more persistent and gradual increase in core and headline inflation."
  - Implies a policy rate response "ranging between 0.9 and 2 percentage points by the end of 2023," depending on the exchange rate regime assumed.
  - Interpretation: "in contrast to the food prices shocks, the central bank needs to react to sources of global inflation shocks that might persistently affect the region, in particular to those triggering other channels of inflationary pressures in the economy."

### External risks that could push inflation up (Section 2)
- Potential upward pressures:
  - Further aggravation of sanctions against Russia.
  - Tighter than expected monetary policy in developed countries.
  - Further increases in international transportation bottlenecks.
  - Further increases in European natural gas and fertilizers prices.
  - Further depreciation of the Euro versus the U.S. dollar.
- Domestic fiscal and policy considerations:
  - "Fiscal consolidation is essential not only to maintain an adequate level of external reserves, but it is also crucial for price stability as higher deviations of fiscal deficit from current trends would exert additional pressure on inflation."
  - If subsidies and price controls on essential goods "implemented this year to contain price increases are not sustainable for much longer, one may expect again additional pressure on inflation."
- Supply-side shocks:
  - "Some producing countries have been particularly affected by weather conditions and security issues."

### Monetary policy trade-offs and operational constraints (Section 2)
- Tightening monetary policy:
  - "Normally entails costs in terms of growth," but "contributes to the mitigation of inflationary pressures as well as the preservation of foreign exchange reserves."
- Role of foreign reserves:
  - "The level and evolution of foreign reserves are indeed important factors considered by the BCEAO."
  - Article 76 of the BCEAO statutes specifies a minimum threshold: "the BCEAO should not let the monthly average of foreign exchange reserves fall below 20 percent of its sight liabilities (banknotes in circulation and deposits at the central bank) for three consecutive months."
  - Note: "exchange rate stability is not a de jure objective of monetary policy."
- Influence of the euro area:
  - BCEAO "does not traditionally follow the monetary policy decisions of the ECB (as visible in the Figure below) mainly due to its capital controls," but markets expect euro-area tightening to be "substantial both in terms of speed and levels," which "may place unusual pressure on WAEMU monetary policy."
  - Recommendation: "it is important to further monitor these developments."

### Policy guidance and monitoring (Section 2)
- Core guidance:
  - Avoid contagion and second-round effects to prevent "de-anchored expectations."
  - Monetary policy should be "data-dependent based on economic developments," given the "numerous external and internal risks affecting inflation prospects," which "should be carefully monitored."

*Source: IMF staff (sipea2023038 - Section 1 and Section 2).*

### Section 1

### sipea2023038 - Section 1

### I. Recent Developments in the WAEMU Inflation
- Headline inflation rose sharply beginning in 2020 after recording negative rates throughout 2019, peaking in August (year unspecified in text) at 8.8 percent and slowing to 8.0 percent in November 2022.
- Increasing heterogeneity across member countries: in November 2022, Burkina Faso inflation was 12.2 percent and Benin was 3.2 percent.
- Historical component contributions (January 1999–October 2022):
  - Food contributions averaged 1.2 percentage points against a 2.3 percent average inflation rate for the period.
  - Housing and transport jointly contributed approximately 0.5 percentage points to headline inflation.
  - The remaining nine components contributed 0.6 percentage points jointly.
- Consumption-basket weights in WAEMU:
  - Food weight: 42 percent.
  - Housing weight (including energy items): 11 percent.
  - Transportation weight (including energy items): 9 percent.
- Crisis episode (global financial crisis): headline inflation rose from about 2 percent to over 10 percent then returned to target within ~two years; fluctuation driven mainly by food prices—excluding food, inflation stayed close to target.
- Short-term (November 2022) component contributions to inflation:
  - Food: 5.3 percentage points.
  - Housing: 0.7 percentage points.
  - Transportation: 0.6 percentage points.
- Historical peak (August 2008) component contributions:
  - Food: 7.4 percentage points.
  - Housing: 0.5 percentage points.
  - Transportation: 0.75 percentage points.
- Historical averages:
  - Food: 1.2 percentage points.
  - Housing: 0.2 percentage points.
  - Transportation: 0.3 percentage points.
- Country-level patterns:
  - Food contributions particularly relevant in Burkina Faso.
  - Togo and Côte d'Ivoire show more diversified contributions across inflation components.
- International food price pass-through: domestic food prices tend to follow international prices closely; IMF WEO forecasts expect international food price inflation to decline significantly, suggesting a conceivable quick reversal of regional food inflation as in past episodes.

### II. Sectoral Dynamics and Inflation Contagion
- Non-food inflation dynamics:
  - Non-food inflation rarely exceeded the target over the past two decades.
  - Over the past year-and-a-half (relative to Jan 2021–Nov 2022 context), non-food inflation increased from about 0.5 percent to about 2.7 percent, driven mainly by three categories: housing, transportation (both driven mainly by higher energy prices), and “other” items (services).
  - Contribution from energy prices to headline inflation has remained muted despite large increases in international oil prices due to domestic mitigating policies in most countries.
- Food inflation drivers (Jan 2021–Jun 2022 notable increases):
  - Bread: -0.4 to 15.9 percent.
  - Cooking oil: 4.5 to 19.4 percent.
  - Flour and groats: 0.7 to 14.8 percent.
- Official core inflation:
  - Excludes “fresh” food and energy, but keeps several non-perishable and other food items.
  - Contribution from food inflation to headline rose from 1.4 percent in January 2021 to 5.3 percent in November 2022.
  - Official core inflation breached BCEAO’s upper target limit in August 2021, reaching 5.3 percent in November 2022.
  - Inclusion of many food components in official core weakens its adequacy to capture underlying inflation trend.
- Persistence index (AR(1) with a 48-month rolling window):
  - Increased from 0.10 in January 2021 to 0.55 in September 2022.
  - Historical average: 0.2.
  - Higher persistence implies stronger influence of past inflation on expectations and price formation, complicating monetary control.
  - Non-food inflation persistence: was negative in past few years (indicating mean month-over-month non-food inflation around zero) but recently moved toward zero from negative as non-food inflation averaged a positive number.
- Inflation expectations (BCEAO survey of companies' leaders):
  - Share expecting inflation above 3 percent in a one-year horizon: increased from 11.9 percent in December 2021 to 28.5 percent in September 2022.
  - Share expecting one-year inflation between 1 percent and 3 percent: decreased from 81.1 percent to 66.8 percent over the same period.
- Diffusion index (share of items with inflation above thresholds; 126 headline items):
  - Share with inflation rates above 2 percent surpassed 50 percent in March 2022 and reached 68 percent in September 2022 (previously around 30 percent since 2019).
  - Diffusion index above 3 percent has also been rising since 2021 and is now above 50 percent.
  - Excluding food, housing and transport, highest increases are in beverages & tobacco, clothing, furnishing, and “others” (services) — indicating rising potential pass-through from food/energy to other prices.
  - At a 3 percent threshold, contagion evidence prevails primarily in beverages & tobacco and furnishing; hotels and restaurants are very volatile (3 items) and closely related to food and energy.
- Distributional changes:
  - Histogram evidence (Sep 2020–Sep 2022): mean inflation higher, distribution wider and shifted to the right—greater dispersion toward higher inflation—driven mainly by food, housing, and transport; other categories showed more contained changes.
- Non-food and service item surges:
  - Items outside food and energy with major price increases include services such as hairdresser, insurance, maintenance and repair for housing, clothing.
  - Many of these items were under deflation or near 0 percent one year earlier, suggesting supply-demand imbalances and rebound after the pandemic; sustained surges would indicate second-round effects.
- Data limitations:
  - Very detailed breakdown of sectoral inflation data is not available for recent months.
  - Scarce availability of timely wage data and high informality impede analysis of second-round mechanisms, wage-price pass-through, and wage-price spiral assessment.

### III. Going Forward: Inflation Forecasts and Monetary Policy Implications
- BCEAO target: forward-looking, 2 percent year-over-year inflation rate with symmetrical ceiling and floor of 1 percentage point within a 24-month horizon (i.e., target band 1–3 percent).
- Forecasting methodologies used:
  - SARIMAX (Seasonal Auto-Regressive Integrated Moving Average with exogenous factors).
  - AFRMOD-FSGM (African Module of the Flexible System of Global Models) based on Andrle et al. (2015) applied to WAEMU.
- SARIMAX specification and data:
  - Dependent variable: WAEMU headline inflation (year-over-year quarterly frequency).
  - Exogenous variables: international fuel and foods prices and the nominal effective exchange rate (IMF WEO database).
  - Estimation period: 1997Q1–2022Q2.
  - Forecast period: 2022Q3–2024Q4.
  - Assumption: recent depreciation of the nominal effective exchange rate abates so yearly change converges to zero during forecast period.
  - Limitation: econometric exercise cannot explore alternative monetary policy responses beyond average historical behavior embodied in estimated coefficients.
- AFRMOD-FSGM model features:
  - Real GDP determined short-run by demand components, long-run by potential output.
  - Fiscal policy stabilizes debt-to-GDP in long run and responds to output gap in short run.
  - Monetary policy via interest rate reaction function (inflation-forecast based rule).
  - Two exchange rate regime scenarios presented due to capital controls and some monetary independence:
    - Fixed exchange rate with small addition of country risk premium.
    - Managed float.
  - Three commodities in model: oil, metals, and food; annual frequency; sticky goods prices.
- Model simulation outcomes:
  - SARIMAX and AFRMOD-based forecasts suggest inflation expected to decrease to 1¾ percent by 2024Q4 based on WEO GAS projections of lower fuel and food prices and minimal exchange rate pressure.
  - SARIMAX result: by end-2024 inflation expected to reach 1¾ percentage points (within target range), implying no monetary policy change required based on this calculation.
- AFRMOD shock scenarios:
  - Shock 1: Increase in global food prices of 30 percent in 2022 (annual calibration).
    - Result: short-lived headline inflation reaction in WAEMU, increasing by 5 percentage points in 2022 and fading in subsequent years.
    - Effect on traditional core inflation (excluding food and energy): negligible.
  - Shock 2: Increases in Euro area and US inflation path (core inflation path obtained from WEO; inflation shock = WEO path minus 2 percent steady-state core for euro and US).
    - Result: headline inflation in WAEMU gradually increases by approximately 1 percentage point and slowly decreases by half percentage point by end-2026; small impact cushioned by a moderate central bank monetary policy reaction.
- Confidence intervals (AFRMOD forecast charts):
  - Dark shaded purple area: 50% confidence interval.
  - Light shaded purple area: 90% confidence interval.

### IV. Other Factors Relevant for Inflation Developments and Desirable Monetary Response
- Key structural and supply-side constraints exacerbating food inflation:
  - Climate shocks.
  - Security issues.
  - Health crises.
  - Constraints on local production contribute to vulnerability to global food price shocks.
- Policy containment of energy price pass-through:
  - Domestic policies in most countries have muted the contribution of international oil price increases to headline inflation.
- Monetary policy implications:
  - Given forecasts (SARIMAX and AFRMOD) pointing to inflation around 1¾ percent by 2024Q4, current stance does not call for a change in monetary policy per SARIMAX.
  - The AFRMOD scenarios suggest that large global food shocks can cause substantial but short-lived headline inflation increases, while global core inflation increases could transmit modestly into WAEMU headline inflation; a moderate monetary policy reaction can cushion these effects.
- Monitoring priorities for policy:
  - Track international food and fuel price paths (WEO projections are key inputs).
  - Monitor persistence index and diffusion index developments to assess entrenchment and spread of inflation across items.
  - Improve data availability on wages and labor markets to better assess second-round effects, wage-price pass-through, and inform monetary policy responses.

*Source: IMF staff (sipea2023038 - Section 1).*

### Section 2

### sipea2023038 - Section 2

### Model limitations and implications
- The SARIMAX model is "well-grounded in the key drivers of inflation" but "remains a simple benchmark" and "does not encompass a broad set of fundamentals in a general equilibrium setting."
- If "persistent and second round effects are stronger than over the historical sample over which the SARIMAX model was estimated, the model would not be able to capture these effects."
- In the case of a global food price shock, the model indicates:
  - Headline inflation: short-lived reaction.
  - Core inflation: very limited reaction.
  - Policy implication: "the central bank does not need to react" for a "pure, short-lived supply shock with no further inflation contagion across sectors nor second-round effects."

### Simulation results for global inflation shocks
- A positive shock to the Euro area and US inflation paths produces:
  - "A more persistent and gradual increase in core and headline inflation."
  - A policy rate response "ranging between 0.9 and 2 percentage points by the end of 2023," depending on the exchange rate regime assumed.
- Interpretation: "in contrast to the food prices shocks, the central bank needs to react to sources of global inflation shocks that might persistently affect the region, in particular to those triggering other channels of inflationary pressures in the economy."

### External risks that could push inflation up
- Developments that could exert upward pressure on inflation:
  - Further aggravation of sanctions against Russia.
  - Tighter than expected monetary policy in developed countries.
  - Further increases in international transportation bottlenecks.
  - Further increases in European natural gas and fertilizers prices.
  - Further depreciation of the Euro versus the U.S. dollar.
- Domestic fiscal and policy considerations:
  - "Fiscal consolidation is essential not only to maintain an adequate level of external reserves, but it is also crucial for price stability as higher deviations of fiscal deficit from current trends would exert additional pressure on inflation."
  - If subsidies and price controls on essential goods "implemented this year to contain price increases are not sustainable for much longer, one may expect again additional pressure on inflation."
- Supply-side shocks:
  - "Some producing countries have been particularly affected by weather conditions and security issues."

### Monetary policy trade-offs and operational constraints
- Tightening monetary policy:
  - "Normally entails costs in terms of growth," but "contributes to the mitigation of inflationary pressures as well as the preservation of foreign exchange reserves."
- Role of foreign reserves:
  - "The level and evolution of foreign reserves are indeed important factors considered by the BCEAO."
  - Article 76 of the BCEAO statutes specifies a minimum threshold: "the BCEAO should not let the monthly average of foreign exchange reserves fall below 20 percent of its sight liabilities (banknotes in circulation and deposits at the central bank) for three consecutive months."
  - Note: "exchange rate stability is not a de jure objective of monetary policy."
- Influence of the euro area:
  - Although the BCEAO "does not traditionally follow the monetary policy decisions of the ECB (as visible in the Figure below) mainly due to its capital controls," markets expect the euro-area tightening to be "substantial both in terms of speed and levels," which "may place unusual pressure on WAEMU monetary policy."
  - Recommendation: "it is important to further monitor these developments."

### Policy guidance and monitoring
- Avoid contagion and second-round effects to prevent "de-anchored expectations."
- Monetary policy should be "data-dependent based on economic developments," given the "numerous external and internal risks affecting inflation prospects," which "should be carefully monitored."

*Source: sipea2023038 - Section 2*

---


_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023038.pdf_