Effects of exogenous shocks on the monetary policy credibility: evidence from the West African Economic and Monetary Union region

In the last five years, external shocks have been persistent. Although the effect of these shocks on inflation has received attention, their effects on the credibility of monetary policy have been little explored, especially in the context of monetary union. This paper seeks to empirically investigate the effect of selected exogenous shocks on the credibility of monetary policy in the West African Economic and Monetary Union (WAEMU) region from 2006 to 2023. Using the heterogeneous Structural Vector Autoregressive (SVAR) panel model and Mixed-Frequency Vector Autoregressive (MF-VAR), we find that external shocks are associated with a deterioration in the credibility of monetary policy in the short term. However, the effect varies according to the type of climatic shock on the one hand, and commodity prices on the other. Climate shocks have a persistent effect on the credibility of monetary policy compared with commodity price shocks. Our results suggest that monetary authorities should pay attention to external shocks. Given that they have limited control over external shocks, particularly climate shocks, they should contribute to collective action in response to the challenges posed by climate change by setting up or supporting green projects in the countries of the union. The findings highlight the necessity of coordinating monetary and fiscal policy to reduce inflation during these shocks. External climate-related shocks and global commodity prices continue to be persistent. Analysing data from countries in the WAEMU region, we found that negative shocks correlate with a decline in the credibility of monetary policy due to their effects on economic activity and domestic prices.