Regional Integration and Policy Challenges in Africa

A. Elhiraika, A. Mukungu, W. Nyoike, A. Elhiraika, A. Mukungu, W. Nyoike

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137462084
• Topic: Betriebswirtschaft
• Subtopic: Business allgemein

The role of integration as a catalyst for economic growth, development and insulation from global shocks has made the concept of regional integration even more attractive to states. This books contains compelling arguments and empirical observations that detail some of the key opportunities governments in Africa are pursuing.

Part I

Convergence, Monetary Policy, and Economic Growth

1

Can Inflation in WAMZ Converge without Monetary Policy Coordination?

Emmanuel Dele Balogun

JEL codes: E31, F41.

Keywords: exchange rate, inflation differentials, panel data, price convergence, WAMZ members.

1 Introduction

A precondition for the introduction of a common currency (the Eco) to the West African Monetary Zone (WAMZ) is sustained low inflation in its member countries of Gambia, Ghana, Guinea, Nigeria, and Sierra Leone. It is generally expected that these countries will pursue ex ante independent monetary policies capable of narrowing inflation differentials and fostering convergence around a single digit.

Since the launch of the WAMZ in 2000, this primary convergence criterion has been difficult to fulfill. Several studies (Ojo, 2005; Nnanna, 2007; Adamgbe and Agu, 2012) show there is poor prospects for inflation convergence given the asymmetries in monetary policies. If progress is to be made towards convergence, it is necessary to understand what generates inflation differentials among these countries. In particular, there is a need to assess the role of monetary policy, especially interest rates, exchange rates, and credit policy, in generating inflationary spirals.

The objectives of this chapter are to establish the extent of divergence in independent monetary policy conditions and to ascertain the prospects for inflation convergence without ex ante monetary policy coordination to a pre-set benchmark, given the asymmetry in the WAMZ. The chapter presents a brief review of the related literature in Section 2; reviews the theoretical and analytical models in Sections 3 and 4; presents the results in Sections 5 to 8; and offers concluding remarks and policy implications in Section 9.

2 Related literature

Various models have been used to analyze inflation differentials, especially in the euro area (Hofmann and Remsperger, 2005; Angeloni and Ehrmann, 2007; Honohan and Lane, 2003; Horvath and Koprnicka, 2008; Mara and André, 2011). These studies were designed to validate ex post the doctrine of the “law of one price” which holds that inflation in the euro zone, with common currency and monetary policy pursuits, ought to converge with no significant differential. The empirical approach of these studies was econometric, differing only in terms of the model specification, scope, and the span of data. While Hofmann and Remsperger (2005) analyze inflation differentials with a panel Generalized Method of Moments (GMM) over the period of 1999–2004, Angeloni and Ehrmann (2007) analyze both output and inflation differentials observed across the euro area over the period of 1998–2003 through aggregate demand and supply equations. Their findings suggest that the observed inflation differentials are mainly influenced by differences in cyclical positions and fluctuations in the effective exchange rate combined with a rather high level of inflation persistence, while the proxies of price-level convergence was not significant.

A similar study by Honohan and Lane (2003) uses the panel data model to assess the driving factors of inflation differentials in the euro area over the period 1999–2001. Their findings show that a member country’s external exposure, cyclical position, fiscal policy, and its price-level convergence are vital determinants of inflation differentials in the euro area. Also, in a more recent study, Horvath and Koprnicka (2008) examine the determinants of inflation differentials in a panel of new European Union (EU) member states compared to the euro area during 1997–2007. Their main results are that the exchange rate’s appreciation and higher price levels in new EU members is associated with narrower inflation differentials vis-à-vis the euro area, while fiscal deficit and positive output gaps seem to contribute to higher inflation differentials. Their conclusion is that real convergence factors rather than cyclical variation are more important for inflation developments in the new EU members, as compared to the euro area.

A more recent study by Mara and André (2011) presents new evidence on inflation differentials in the euro area based on data that span 1999–2010, covering the recent global financial crisis. Adopting both descriptive and econometrics methods, the authors analyze the evolution of inflation dispersion and differentials since the start of the Economic and Monetary Union (EMU). Their findings confirm the existence of inflation differentials for the entire sample period, predominantly influenced by data trends in 1999–2006, given the relative price convergence in the crisis era of 2007–2010. A gravity model estimation confirms that price-level equalization, productivity differentials, differences in cyclical positions, and labor and product market rigidities are important determinants of inflation differentials. They conclude that inflation differentials are not the result of equilibrating, transitory forces but rather of persistent structural and country-specific factors which call for structural reforms in labor and product markets and countercyclical fiscal policy measures at the individual country level.

However, more related to the focus of this chapter are studies (Popkova et al., 2012; Ary Tanimoune et al., 2007; Adamgbe and Agu, 2012; Taylor, 2013) which discuss inflation as part of the macroeconomic convergence criteria in the West African Economic and Monetary Union (WAEMU), the proposed WAMZ, and the Economic Community of West African States (ECOWAS) monetary union. Popkova et al. (2012) note the lack of consensus in the literature about the relative effectiveness of monetary policy integration in fostering macroeconomic convergence. They argue that aside from the relative ineffectiveness of independent monetary and exchange rate policies in influencing domestic economic activities, the associated cost of country-specific shocks are much higher than those implied by a monetary union. They conclude that the ex ante adoption of common monetary and exchange rate policies via regional economic integration may have positive implications for macroeconomic convergence and for accelerating the emergence of a regional currency.

Ary Tanimoune et al. (2007) analyze a panel data set which spans from 1990 to 2006 to evaluate the implication of country-specific inconsistencies between fiscal and monetary policies for the emergence of a common currency in ECOWAS. The authors categorize the monetary and fiscal policy stance (measured by the primary structural fiscal balance and the monetary condition index respectively) into four possible policy regimes, especially in the WAEMU subsample where integration is deepest. Their findings confirm the existence of incoherence in the policy mix and heterogeneity in the economic structure. They conclude that fostering more policy coherence through ex ante regional policy coordination seems a necessary precondition to macroeconomic convergence.

In a paper by Taylor (2013), the preparedness of WAMZ countries for the formation of the proposed common currency, the Eco, is evaluated based on the guidelines of the Optimum Currency Area (OCA) framework with specific focus on macroeconomic shocks, the level of product, the diversification of the export base, and the extent of trade among member countries. The empirical methods adopted by the author include the construction of correlation matrices for inflation and the % growth in the Gross Domestic Product (GDP), a Gini index defined as a measure of producer income disparity to gauge the extent of similarity across sectors (namely agriculture, manufacturing, and services), and a gravity equation which includes variables to study the added effect of membership in ECOWAS, WAMZ, and the Communauté Financière Africaine (CFA) currency zone. Contrary to the original hypothesis that these countries are not sufficiently prepared, the mixed results indicate that over time the WAMZ countries may successfully be able to form a common currency with ex ante policy integration, and starting among countries that are the most similar.

Adamgbe and Agu (2012) evaluate through dynamic general equilibrium models estimated by Bayesian estimation techniques, the monetary policy preferences in the WAMZ which show that in spite of regional efforts towards achieving convergence, the single digit inflation objective has not been achieved. Their analysis shows preferences for output stabilization instead of inflation which is an indication of a passive use of monetary policy as a demand management tool.

In summary, the literature reviewed evaluate the extent to which adoption of common monetary policies fosters price convergence in the euro zone (Hofmann and Remsperger, 2005; Angeloni and Ehrmann, 2007; Honohan and Lane, 2003; Horvath and Koprnicka, 2008; Mara and André, 2011) and discuss inflation as part of the macroeconomic convergence criteria in the WAEMU, the proposed WAMZ, and the ECOWAS monetary union (Popkova et al., 2012; Ary Tanimoune et al., 2007; Adamgbe and Agu, 2012; Taylor, 2013). However, none of the studies focus specifically on evaluating the prospect of inflation convergence in the WAMZ in the absence of ex ante monetary policy coordination which is a key criterion that must be attained by a majority of participating countries before the commencement of a monetary union.

This study therefore differs from Taylor (2013) on three grounds: the scope, objective and method of analysis. Whereas Taylor’s study spans the period of 1990–2008 and the analysis uses a gravity model (for trade data), a correlation matrix (for GDP and inflation data), and a Gini of similarity (for diversification data), this study analyzes data which span 1986 to 2012 by using a pooled regression method to establish the aggregate effect of independent monetary policies on the potential for inflation convergence. The aim of this approach is to show there is limited likelihood that the monetary policy conditions in the participating countries of the WAMZ can converge in the absence of monetary policy coordination. This challenges the...

Table of contents

• Cover
• Title
• Overview
• Part I  Convergence, Monetary Policy, and Economic Growth
• Part II Institutional Integration and Policy Coordination
• Part III  Financial Integration and Regulation
• Part IV  Fiscal Policy and Regional Integration
• Conclusion
• Index