Question

Central African CFA franc (XAF) is a currency used by 14 African countries and it is pegged to the Euro (fixed ECFA/EURO). The currency union countries are committed to protect the CFA franc, and the fixed exchange rate regime and capital mobility, under all circumstances. Suppose that a political scandal in the area causes disturbances across multiple countries. Due to this news, investors revise their exchange rate forecasts and expect CFA franc to depreciate against the euro in the future. • What happens in the FX market following the change in exchange rate forecasts? Explain which schedule(s) shift and why. Assume CFA franc to be the home currency. • How should the monetary authority respond to the revision in the exchange rate forecast if they are committed to keep the peg? Explain which schedule(s) shift and why.

Answer 1

Answer:

There will be no depreciation (shift) because it is not an open market FX floating rate exchange

Explanation:

All over the world, some countries operate floating rate exchange policy in which the value of a currency increases or decreases based on demand and supply in the forex market.

In the case of Central African CFA (XAF), there would not be a shift in the value of the currency in the FX market as a result of the currency value being controlled rigidly (Non-floating rate exchange method) irrespective of the political scandal in some areas of the region or not. This is also similar to the situation where by a country in the CFA region still has a stable currency exchange rate against Euro irrespective of the terrorism activities or economic situation they are passing through at that particular point in time.