Abstract
This study employs annual time series data from 1982 to 2019 for sixteen (16) West Africa countries to investigate the stability of money demand in these countries and the feasibility of the proposed West African Monetary Zone. From a standard money demand function to a bounds test method, co-integration and error correction model, we found significant heterogeneity and divergence across the sixteen (16) countries. The highlight of the findings is that co-integration of the money demand function is only recorded in Ghana but exhibited partial stability from the CUSUMSQ (cumulative sum squared) test. In Nigeria, the biggest economy in West Africa has no co-integration and is only partially stable from the results of the CUSUM test. The significant divergence across these countries as indicated by the test of co-integration, CUSUM (cumulative sum) test, CUSUMSQ (cumulative sum squared) test, the short and long-run factors and error correction in the event of a shock, makes it crucial for the need to include country specific idiosyncratic monetary policy features in the event of a monetary zone in West Africa, and crucial to ensure convergence in their money demand function.
Highlights
From a standard money demand function to a bounds test method, co-integration and error correction model, we found significant heterogeneity and divergence across the sixteen (16) countries
From the concerted effort among West African nations towards the formation of a monetary zone, it is significant to draw the relevant lessons from both global financial meltdowns and the experiences of other monetary zones such as the Euro zone
This is because the success of a monetary zone of any kind apparently depends on the stability and the long-run nexus between money demand and other macro-economic variables
Summary
A monetary zone or a common currency area is defined as an economic area within which exchange rates are fixed. Even though some countries within West Africa (termed as Francophone) countries have the same currency (CFA) as medium of exchange, there are still many variations in their respective levels of monetary aggregates. Volatility in external factors significantly affects the fragile economies of these countries. These factors such as changes in international interest rate and exchange rate have significant effects on domestic currency holdings and asset allocations
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