REER Imbalances and Macroeconomic Adjustments in the Proposed West African Monetary Union

Asongu, Simplice A (2013): REER Imbalances and Macroeconomic Adjustments in the Proposed West African Monetary Union.

Abstract

With the spectre of the Euro crisis hunting embryonic monetary unions, we use a dynamic model of a small open economy to analyze REERs imbalances and examine whether the movements in the aggregate real exchange rates are consistent with the underlying macroeconomic fundamentals in the proposed West African Monetary Union (WAMU). Using both country-oriented and WAMU panel-based specifications, we show that the long-run behavior of the REERs can be explained by fluctuations in the terms of trade, productivity, investment, debt and openness. While there is still significant evidence of cross-country differences in the relationship between underlying macroeconomic fundamentals and corresponding REERs, the embryonic WAMU has a stable error correction mechanism with four of the five cointegration relations having signs that are consistent with the predictions from economic theory. Policy implications are discussed and the conclusions of the analysis are a valuable contribution to the scholarly and policy debate over whether the creation of a sustainable monetary union should precede convergence in macroeconomic fundamentals that determine REER adjustments.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rate; Macroeconomic impact; Proposed WAMU
• Subjects: F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F3 - International Finance > F33 - International Monetary Arrangements and Institutions; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F42 - International Policy Coordination and Transmission; F - International Economics > F6 - Economic Impacts of Globalization > F61 - Microeconomic Impacts; O - Economic Development, Innovation, Technological Change, and Growth > O5 - Economywide Country Studies > O55 - Africa

References

Abdih, Y., & Tsangarides, C., (2010). “FEER for the CFA franc”, Applied Economics, 42, pp. 2009-2029.

Acemoglu, D., Johnson, S., Robinson, J. A., & Thaicharoen, Y., (2003). “Institutional causes, macroeconomic symptoms: volatility, crises and growth”, Journal of Monetary Economics, 50, pp. 49-123.

Alagidede, P., (2008). “African Stock Market Integration: Implications for Portfolio Diversification and International Risk Sharing”, Proceedings of the African Economic Conferences 2008.

Alagidede, P., Coleman, S., & Cuestas, J. C., (2012). “Inflationary shocks and common economic trends: Implications for West African Monetary Union membership”, Journal of Policy Modeling, 34(3), pp. 460-475.

Alagidede, P., Tweneboah, G., & Adam, A. M., (2008). “Nominal Exchange Rates and Price Convergence in the West African Monetary Zone”, International Journal of Business and Economics, 7(3), pp. 181-191.

Asongu, S. A., (2013a). “Are Proposed African Monetary Unions Optimal Currency Areas? Real, Monetary and Fiscal Policy Convergence Analysis”, African Journal of Economics and Management Studies: Forthcoming.

Asongu, S. A., (2013b). “Real and Monetary Policy Convergence: EMU Crisis to the CFA zone”, Journal of Financial Economic Policy, 5(1), pp. 20-38.

Asongu, S. A., (2013c). “Real Effective Exchange Rate Imbalances and Macroeconomic Adjustments: evidence from the CEMAC zone”, African Governance and Development Institute Working Paper.

Asongu, S. A., (2013d). “A Short-run Schumpeterian Trip to Embryonic African Monetary Zones”, Economics Bulletin, 33(1), pp. 859-873.

Asongu, S. A., (2013e), “Long-term effects of population growth on aggregate investment dynamics: selected country evidence for Africa”, African Journal of Economic and Management Studies: Forthcoming.

Babazadeh, M., & Farrokhnejad, F., (2012). “Effects of Short-run and Long-run Changes in Foreign Exchange Rates on Banks’ Profit”. International Journal of Business and Management, 7 (17), pp. 70-77.

Camarero, M., & Tamarit, C., (2002). “A panel cointegration approach to the estimation of the peseta real exchange rate”. Journal of Macroeconomics. 24, pp. 371-393.

Celasun, O., & Justiniano, A., (2005). “Synchronization of output fluctuations in West Africa: Implications for monetary unification”, IMF Working Paper.

Chen, R., Milesi-Ferretti, G. M., & Tressel, T., (2012). “External Imbalances in the Euro Area”, IMF Working Paper 12/236.

Cheung, Y. W., & Lai, K. (1993). « A fractional cointegration analysis of purchasing power parity” . Journal of Business and Economics Statistics, 11, pp. 103-112.

Debrun, X., Masson, P., & Pattillo, C., (2005). “Monetary union in West Africa: Who might gain, who might lose and why?”, Canadian Journal of Economics, 38(2), pp. 454-481.

Edwards, S., (1989). Real Exchange Rates, Devaluation and Adjustment: Exchange Rate Policy in Developing Countries, MIT Press, Cambridge, MA.

Edwards, S., & van Wijnbergen, S., (1986). “The welfare effects of trade and capital market liberalization”, International Economic Review, 27(1), pp. 141-148.

Engle, R. F., & Granger, W. J., (1987). “Cointegration and error correction: Representation, estimation and testing”, Econometrica, 55, pp. 251-276.

Gries, T., Kraft, M., & Meierrieks, D., (2009). “Linkages between financial deepening, trade openness, and economic development: causality evidence from Sub-Saharan Africa”. World Development, 37(12), pp. 1849-1860.

Im, K. S., Pesaran, M. H., & Shin, Y., (2003). “Testing for unit roots in heterogeneous panels”. Journal of Econometrics, 115, pp. 53-74.

Johansen, S., (1995). Likelihood-based Inference in Cointegrated Vector Autoregressive Models, Oxford University Press, United Kingdom.

Kao, C., (1999). “Spurious regression and residual-based tests for cointegration in panel data”. Journal of Econometrics, 90, pp. 1–44.

Keane, J., Cali, M., & Kennan, J., (2010). “Impediments to Intra-Regional Trade in Sub-Saharan Africa”, Overseas Development Institute, http://www.odi.org.uk/sites/odi.org.uk/files/odi-assets/publications-opinion-files/7482.pdf (accessed: 18/11/2013).

Levin, A., Lin, C. F., & Chu, C. S., (2002). “Unit root tests in panel data: asymptotic and finite-sample properties”. Journal of Econometrics, 108, pp. 1-24.

Liew, V. K., (2004). “Which lag selection criteria should we employ?”. Economics Bulletin,3(33), pp. 1-9.

Lutkepohl, H., Saikkonen, P., & Trenkler, C., (2000). “Maximum Eigenvalue Versus Trace Test for the Cointegration Rank of a VAR process”, Humboldt University Berlin, http://edoc.hu-berlin.de/series/sfb-373-papers/2000-83/PDF/83.pdf (accessed: 18/11/2013).

Maddala, G. S., & Wu, S., (1999). “A comparative study of unit root tests with panel data and a new simple test”. Oxford Bulletin of Economics and Statistics, 61, pp. 631-52.

Mussa, M., (1974). “Tariffs and the distribution of income: the importance of factor specificity, substitutability and intensity in the short and long run” Journal of Political Economy, 82(6), pp. 1191-1203.

Obstfeld, M., & Rogoff, K., (1996). Foundations of International Macroeconomics, MIT Press, Cambridge.

Pedroni, P., (1999). “Critical values for cointegration tests in heterogeneous panels with multiple regressors”. Oxford Bulletin of Economics and Statistics, Special Issue .pp. 653-670.

Saxegaard, M., (2006). “Excess liquidity and effectiveness of monetary policy: evidence from sub-Saharan Africa”, IMF Working Paper 06/115.

Rolfe, R. J., & Woodward, D. P., (2004). “Attracting foreign investment through privatization: the Zambian experience”, Journal of African Business, 5(1), pp.5-27.

Tsangarides, C. G., & Qureshi, M. S., (2008). “Monetary Union Membership in West Africa: A Cluster Analysis”, World Development, 36(7), pp. 1261-1279.

Waliullah, Kakar, M. K., Kakar, R., & Khan, W., (2010). “The Determinants of Pakistan’s Trade Balance: An ARDL Cointegration Approach”, The Lahore Journal of Economics, 15 (1), pp. 1-26.