Abstract
AbstractThis paper examines generalised purchasing power parity (G‐PPP) and business cycle synchronisation in the East Africa Community with the aim of assessing the prospects for a monetary union. The univariate fractional integration analysis shows that the individual series exhibit unit roots and are highly persistent. The fractional bivariate cointegration tests suggest that there exist bivariate fractional cointegrating relationships between the exchange rate of the Tanzanian shilling and those of the other EAC countries, and also between the exchange rates of the Rwandan franc, the Burundian franc and the Ugandan shilling. The Fractionally Cointegrated Vector AutoRegressive (FCVAR) results imply the existence of a single cointegrating relationship between the exchange rates of the EAC countries. On the whole, there is evidence in favour of G‐PPP. In addition, there appears to be a high degree of business cycle synchronisation between these economies. On both grounds, one can argue that a monetary union should be feasible.
Highlights
This paper aims to assess the prospects for a monetary union in the East African Community (EAC), a group of six countries intending to achieve a common monetary policy and currency by 2024, by considering some of the conditions for an Optimal Currency Area (OCA)
It applies fractional cointegration methods to test whether Generalized Purchasing Power Parity (G-PPP) holds in the EAC
The exchange rate of the Tanzanian shilling is cointegrated with all the other exchange rates, while that of the Rwandan franc is cointegrated with those of the Burundian franc and the Ugandan shilling
Summary
This paper aims to assess the prospects for a monetary union in the East African Community (EAC), a group of six countries intending to achieve a common monetary policy and currency by 2024, by considering some of the conditions for an Optimal Currency Area (OCA). It applies fractional cointegration methods to test whether Generalized Purchasing Power Parity (G-PPP) holds in the EAC. It examines business cycle synchronisation by using the Hodrick-Prescott (HP) filter to decompose GDP into trend and cyclical components and measure the degree of correlation between the latter in this set of countries. Long-memory models have already been estimated in various papers testing for Purchasing Power Parity (PPP). Kaen and Koveos (1982) found evidence of long memory during the flexible exchange rate period (19731979), and Cheung (1993) during the managed floating regime. Baum et al (1999) estimated ARFIMA models for real exchange rates in the post-Bretton Woods era and found no evidence to support long-run PPP. Kaen and Koveos (1982) found evidence of long memory during the flexible exchange rate period (19731979), and Cheung (1993) during the managed floating regime. Baum et al (1999) estimated ARFIMA models for real exchange rates in the post-Bretton Woods era and found no evidence to support long-run PPP. Diebold et al (1991) and Baillie and Bollerslev (1994) reported fractional cointegration with non-stationary but meanreverting cointegrating errors (see the survey by Gil-Alana and Hualde, 2009 for further examples)
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