Macroeconomic Shocks and Trade Flows Within Sub-Saharan Africa: Implications for Optimum Currency Arrangements

Macroeconomic Shocks and Trade Flows Within Sub-Saharan Africa:
Implications for Optimum Currency Arrangements
by Tamim Bayoumi and Jonathan D. Ostry

Africa has more countries than any other continent and hence the
largest number of potential monetary and exchange rate arrangements.
Current arrangements are notable for their diversity, ranging from the
common currency union used by the members of the CFA franc zone to the
freely floating exchange rates of such regional economic powers as South
Africa. Moreover, these arrangements have evolved considerably over the
past three decades as exchange rate arrangements have moved toward greater
flexibility in Africa, as in developing countries more generally.

This paper looks at whether the existing highly fractured monetary
arrangements in Africa correspond to what might be expected from the theory
of optimum currency areas, which considers the economic factors that
determine the gains and costs of adopting a single currency and seeks to
measure these gains and losses. Gains from monetary union come from lower
transaction costs and the elimination of exchange rate variability, while
losses come from the inability to pursue independent monetary policies and
to use the exchange rate as an instrument of macroeconomic adjustment. Both
gains and losses are affected by structural features of the economies
concerned, such as the size of asymmetric real disturbances, openness to
trade, and labor mobility. Although the theory of optimum currency areas
explores the advisability of forming a currency union, it is also relevant
to the broader choice of regional exchange rate arrangements.

The paper presents empirical evidence on the size and correlation of
underlying economic disturbances and intraregional trade across sub-Saharan
Africa. Economic disturbances are calculated from a time-series model of
real GDP per capita, while intraregional trade is calculated from the IMF's
Direction of Trade database. The results indicate that in both dimensions
most African countries have significantly smaller links than those across
the three major industrial countries. As these countries show no signs of
moving toward closer monetary cooperation, it appears unlikely that closer
cooperation will occur within Africa in the near future as it has, for
example, over the last two decades in Europe.

At the same time, the limitations of this exercise should be
recognized. Only two criteria for determining the optimum range of a
currency area are examined. Other potentially important issues, such as
factor mobility, are not discussed. In addition, the results may reflect
poor data on real output and underreporting of regional trade or country-
specific factors that do not reflect the underlying economic structures of
the countries involved. However, the uniformity of the results across
groups of countries in the east, west, and south of the continent suggests
that there is little likelihood of a significant move toward monetary
cooperation over the next few years.