## Dynamic Currency Bloc Formation Based on the Moves of Existing Regional Groups

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---

### Introduction: motivation and scope
- Renewed emphasis on price stability and credible anti-inflation commitment places currency adoption at center stage.
- Transaction benefits from common currencies have increased with growth of international trade in goods and assets.
- Africa characterized by multiplicity of currencies; West Africa (16 countries considered) uses 10 currencies in the sample, and most are not convertible.
- Lack of convertibility and exchange rate variability raise transaction costs and impede intraregional trade; unrecorded transborder trade can be several times official intraregional trade in West Africa.
- Political initiatives referenced:
  - Five West African countries agreed to create a new common currency by 2005 to merge eventually with the West African CFA zone.
  - SADC program to establish a common central bank by 2016 and a common currency by 2018.
  - East Africa Community envisages a common market and monetary union.
  - African Union requested AACB to prepare to establish an African Central Bank; AACB suggested a tentative work program to establish the African Central Bank by the year 2021.
- Objective: examine whether empirical investigation points to gradual emergence of currency blocs in Africa and whether there is economic justification for a single African currency now, using Yehoue (2004) dynamic model of gradual currency-bloc expansion.

### Theoretical background: path dependence and trade-network externalities
- Uses dynamic model (Yehoue, 2004) in which:
  - Currency bloc formation is path dependent.
  - Countries join a currency bloc sooner the more they trade with bloc members.
  - Each additional member attracts others dynamically via trade network externalities.
  - More trade reduces output variance and relative price variance between countries, lowering monetary-policy costs of linkage and increasing net benefits of union.
- Assumes existence of a stable equilibrium bloc configuration for the step-by-step dynamic expansion process.
- Comovements of outputs and prices matter because higher comovement implies lower cost of surrendering monetary autonomy; the paper computes comovement measures along the dynamic path.

### Data and methodology
- Bilateral trade data: IMF Direction of Trade Statistics, expressed in real U.S. dollars, deflated by the U.S. consumer price index and expressed in 1995 U.S. dollars; data available for 1980–2000.
- Real GDP data: World Bank World Development Indicators (WDI); trade share between i and j computed as ratio of (exports + imports) to real GDP, bilateral trade taken as average of reports by countries i and j.
- Outputs and prices: WDI panel with yearly data from 1960 to 2000 (shorter periods used where data missing). Real per capita GDP in 1995 U.S. dollars used for output. Relative prices measured as PPP for GDP divided by U.S. dollar exchange rate. Inflation measured as growth rate of GDP deflator from WDI.
- Comovements: computed measures of lack of comovement of relative output (CY) and relative price (CP); lower values imply greater comovement.
- Trade-to-GDP join threshold applied: 2 percent for ratio of recorded total bilateral trade to GDP between country i and potential anchor j. Rationale: African bilateral trade-to-GDP averages are low; average bilateral trade-to-GDP ratio between any two African countries is about 0.59 percent.
- Focuses on fundamentals (trade patterns and comovements), setting standard convergence criteria (budget deficit, debt–to–GDP) aside.

### Inflation and variability overview (1960–2000 sample facts)
- Several countries experienced very high historical average inflation:
  - Congo, Dem. Rep. of: 1036.22 (In percent)
  - Angola: 819.68 (In percent)
  - Uganda: 55.76 (In percent)
- Of 53 African countries:
  - 3 had average inflation rates above 50 percent.
  - 12 had average inflation rates above 20 percent.
  - 24 had average inflation rates exceeding 10 percent.
- Representative anchors’ average inflation (1960–2000):
  - West Africa CFA zone: approximately 5.5 percent.
  - Central Africa CFA (CAEMU): 7.5 percent.
  - Rand zone: 10 percent.
  - Nigeria (naira): about 18 percent.

### Dynamic bloc formation results — country-by-country moves (trade criterion = 2 percent)
- Using Nigeria as anchor:
  - Only Niger and Côte d’Ivoire meet the 2 percent threshold to join Nigeria.
  - Nigeria’s relatively high inflation (~18 percent) makes it a weak regional anchor under this scenario.
- Using Central African CFA zone (CAEMU) as anchor:
  - No country would join; highest trade share with CAEMU is about 1 percent.
- Using West African CFA zone (WAEMU) as starting point (individual country moves):
  - Early joiners: The Gambia, Mauritania, Liberia, Ghana, and Nigeria.
  - Average trade shares with WAEMU for these early joiners vary from 5.47 percent (The Gambia) to 2.29 percent (Nigeria).
  - Next potential joiners after forming this expanded bloc: Sierra Leone and Equatorial Guinea. Equatorial Guinea does not join because its trade share with CAEMU is 9.67 percent versus 2.14 percent with WAEMU+five countries.
  - Final WAEMU-based individual-moves bloc: WAEMU member countries plus The Gambia, Mauritania, Liberia, Ghana, Nigeria, and Sierra Leone. No other country joins because highest remaining trade share is Guinea with 1.86 percent.
- Using rand zone / Common Monetary Area (CMA) as starting point (individual country moves):
  - Early joiners (ten countries): Malawi, Mozambique, Zimbabwe, Zambia, Mauritius, Seychelles, Liberia, Comoros, Angola, and Tanzania.
  - Average trade shares with CMA for these vary from 21.42 percent (Malawi) to 2.23 percent (Tanzania).
  - Next joiners after expansion: Kenya, Botswana, São Tomé and Príncipe, Democratic Republic of the Congo, and Burundi, with trade shares from around 3.86 percent (Kenya, with expanded CMA list) to 2.07 percent (Burundi).
  - Subsequent joiners: Uganda (5 percent), Rwanda (4.51 percent), Somalia (2.16 percent).
  - Djibouti then joins with trade share of more than 8 percent in the next round.
  - After this expansion no other countries satisfy the 2 percent criterion to join.
- Summary:
  - Three blocs emerge from the country-level dynamic: (1) West African States bloc (WAEMU-centered), (2) Eastern and Southern Africa bloc centered on South Africa (rand/CMA-centered), and (3) existing Central Africa CFA zone (CAEMU).

### Dynamic bloc formation results — group moves (existing regional organizations)
- Applies the 2 percent trade threshold to existing regional groups (group moves) rather than individual countries.
- From WAEMU:
  - The next mover would be the rest of ECOWAS (ECOWAS members not in WAEMU), with trade share 2.27 percent.
  - Once the ECOWAS currency bloc forms, Mauritania would be the next mover.
- From CMA (part of SADC):
  - The rest of SADC country members have the highest trade share with CMA at 7.04 percent; they join CMA to form a larger SADC currency bloc.
  - The group formed by the remaining CBI member countries has the highest trade share with the SADC currency bloc at 2.53 percent; they join, creating a bloc comprising all SADC and CBI member countries.
  - São Tomé and Príncipe, not a member of SADC or CBI, has a trade share of 4.04 percent and might also join the SADC+CBI bloc.
  - No other group meets the criteria to join the SADC, CBI, and São Tomé and Príncipe currency bloc.
- Resulting partition from group moves:
  - Two large blocs emerge: one in western and central Africa, the other in eastern and southern Africa.
  - Almost the entire sub-Saharan Africa partitions into these two blocs.
  - Exceptions retaining individual currencies include Djibouti, Ethiopia, Eritrea, and Sudan (along with North African countries).

### Comovements of prices and outputs (evidence supporting bloc formation)
- Measures: CP (price comovement), CY (output comovement). Lower CP or CY implies greater comovement.
- Price comovement highlights (selected CP values, 1960–2000):
  - WAEMU-based CP: Senegal: 0.04; Niger: 0.04; Mali: 0.04; Benin: 0.05; Nigeria: 0.38; Sudan: 0.48.
  - CMA-based CP: Lesotho: 0.04; South Africa: 0.05; Botswana: 0.08; Nigeria: 0.38; Sudan: 0.50.
  - CMA with SADC CP: Morocco: 0.07; Tunisia: 0.07; Nigeria: 0.37; Sudan: 0.49.
- Output comovement highlights (selected CY values, 1960–2000):
  - WAEMU-based CY: Kenya: 0.03; Algeria: 0.04; Egypt: 0.04; Côte d'Ivoire: 0.05; Nigeria: 0.06; Rwanda: 0.11.
  - CMA-based CY: South Africa: 0.04; Ghana: 0.04; Zambia: 0.05; Madagascar: 0.05; Nigeria: 0.07; Rwanda: 0.12.
  - CMA with SADC CY: Kenya: 0.04; Benin: 0.04; Nigeria: 0.07; Rwanda: 0.12.
- Specific examples:
  - Ghana and Nigeria exhibit a lack of price comovements of the order of 31 and 38 percent respectively.
  - Ghana and Nigeria exhibit a lack of output comovement only of the order of 6 percent each.
  - Guinea-Bissau performed poorly in price and output comovements with WAEMU because it joined the union only in 1997.
- Interpretation caveat:
  - Trade alone may not unambiguously imply stronger comovements. Theory and empirical literature provide competing predictions (Frankel and Rose (1998) vs. Krugman (1993)); intra-African trade exhibits very little intra-industry trade, which may explain low comovements for some countries.

### Anchor choice: major-currency anchoring for an African union
- Empirical average trade–to–GDP ratio with major currency blocs (Africa’s trade shares, In percent):
  - European Economic and Monetary Union (EMU): 22.15
  - United States: 6.95
  - Japan: 2.42
  - If the United Kingdom were to join the EMU (Europe–13), EMU share would rise to 26.67
- Conclusion: the euro appears the most natural candidate anchor for an African union based on trade shares.

### Conclusions, policy implications, and political considerations
- Main messages:
  - Path dependence and trade network externalities imply currency bloc formation is gradual and path dependent.
  - Empirical evidence suggests emergence of multiple regional currency blocs rather than a single continental currency at this time.
  - Two large blocs could partition sub-Saharan Africa: one in West and Central Africa, another around South Africa.
  - Accounting for ex post effects of currency unions (trade increases after union) would tend to reinforce blocs and might induce additional joiners beyond those predicted by historical trade patterns.
- Policy-relevant implications:
  - Gradualism: empirical support for step-by-step expansion of currency blocs rather than immediate continental union.
  - Anchor selection: with Africa’s largest trade share toward EMU (22.15 percent; 26.67 percent if UK joins), the euro seems a natural external anchor for anti-inflation credibility.
  - Political will: decision to surrender national monetary policy ultimately transcends economic criteria; political considerations are decisive.
  - Convergence criteria (budget deficit, debt–to–GDP) are set aside in this fundamentals-based analysis; fiscal discipline could be pursued post-facto if fundamentals align.

### Methodological appendix (computation of comovements)
- Relative output/comovement computation:
  - For each country pair (i, j), use annual series 1960–2000 of relative per capita GDP ln(Yit/Yjt).
  - Fit AR-2 regression: ln(Yit/Yjt)t = a0 + a1 ln(Yit/Yjt)t-1 + a2 ln(Yit/Yjt)t-2 + εtij.
  - Measure of lack of comovement of relative output: CYij = sqrt( (1/(T-3)) * Σt εtij^2 ). The lower CYij, the greater output comovement.
- Relative price/comovement computation:
  - Analogous AR-2 regression for ln(Pit/Pjt) yielding residual utij.
  - Measure of lack of comovement of relative prices: CPij = sqrt( (1/(T-3)) * Σt utij^2 ). The lower CPij, the greater price comovement.
- Data constraints:
  - Fewer observations used when full 1960–2000 series not available.
  - Country-pairs with fewer than 18 observations are dropped.

*Excerpt from "Dynamic Currency Bloc Formation Based on the Moves of Existing Regional Groups" (section 3) of the provided IMF working paper content.*

### References..............................................................................................................

### References................................................................................................................................36

### Tables
- 1a. Mean Annual Inflation Rate, 1960
–2000 ...........................................................................14
- 1b. Inflation Rate Variability, 1960
–2000 ...............................................................................15
- 2a. Country Moves from Nigeria .............................................................................................16
- 2b. Country Moves from Central African Economic and Monetary Union (CAEMU)...........17
- 2c. Country Moves from West African Economic and Moneray Union (WAEMU)...............18
- 2d. Country Moves from Common Monetary Area (CMA)....................................................19
- 3a. Regional Group Moves from WAEMU .............................................................................21
- 3b. Regional Group Moves from CMA  ..................................................................................22
- 4a. Price Comovement Following Trade Dynamic from WAEMU, 1960
–2000 ....................24
- 4b. Price Comovement Following Trade Dynamic from CMA, 1960
–2000...........................26
- 5a. Output Comovement Following Trade Dynamic from WAEMU, 1960–2000... ..............28
- 5b. Output Comovement Following Trade Dynamic from CMA, 1960
–2000........................30
- 6.   Average Trade
–to–GDP Ratio with Major Currency Blocs and Europe-13, 1980–2000..31

### Figures
- 1.   Dynamic Currency Bloc Formation Based on Individual Country Moves........................32
- 2.   Membership in Major Regional Organizations..................................................................33

* _wp0545 - References*

### 3.   Dynamic Currency Bloc Formation Based on the Moves of Existing Regional Groups ..34

### 3.   Dynamic Currency Bloc Formation Based on the Moves of Existing Regional Groups

### Introduction: motivation and scope
- Renewed emphasis on price stability and credible anti-inflation commitment places currency adoption at center stage.
- Transaction benefits from common currencies have increased with growth of international trade in goods and assets.
- Africa is characterized by multiplicity of currencies; West Africa (16 countries considered) uses 10 currencies in the sample context, and most are not convertible.
- Lack of convertibility and exchange rate variability raise transaction costs and impede intraregional trade; unrecorded transborder trade can be several times official intraregional trade in West Africa.
- Monetary integration can reduce instability and distortionary policies (example cited: benefits of the CFA zones).
- Political initiatives across Africa referenced:
  - Five West African countries agreed to create a new common currency by 2005 to merge eventually with the West African CFA zone.
  - SADC program to establish a common central bank by 2016 and a common currency by 2018.
  - East Africa Community envisages a common market and monetary union.
  - African Union requested the Association of African Central Banks (AACB) to prepare to establish an African Central Bank; AACB suggested a tentative work program to establish the African Central Bank by the year 2021.
- Objective of the paper: examine whether empirical investigation points to gradual emergence of currency blocs in Africa and whether there is economic justification for a single African currency now, using Yehoue (2004) dynamic model of gradual currency-bloc expansion as theoretical background.

### Theoretical background: path dependence and trade-network externalities
- Uses dynamic model from Yehoue (2004) in which:
  - Currency bloc formation is path dependent.
  - Countries join a currency bloc sooner the more they trade with bloc members.
  - Each additional member attracts others dynamically via trade network externalities.
  - More trade reduces output variance and relative price variance between countries, lowering monetary-policy costs of linkage and increasing net benefits of union.
- Assumes existence of a stable equilibrium bloc configuration for the step-by-step dynamic expansion process.
- Comovements of outputs and prices matter because higher comovement implies lower cost of surrendering monetary autonomy; the paper computes comovement measures along the dynamic path.

### Data and methodology
- Bilateral trade data: IMF Direction of Trade Statistics, expressed in real U.S. dollars, deflated by the U.S. consumer price index and expressed in 1995 U.S. dollars; data available for 1980–2000.
- Real GDP data: World Bank World Development Indicators (WDI); trade share between i and j computed as ratio of (exports + imports) to real GDP, bilateral trade taken as average of reports by countries i and j to address reporting discrepancies.
- Outputs and prices: WDI panel with yearly data from 1960 to 2000 (shorter periods used where data missing). Real per capita GDP in 1995 U.S. dollars used for output. Relative prices measured as PPP for GDP divided by U.S. dollar exchange rate; relative prices between i and j are ratios of those values. Inflation measured as growth rate of GDP deflator from WDI.
- Comovements: computed measures of lack of comovement of relative output and relative price; lower values imply greater comovement. (Computation details in appendix of source.)

### Key empirical parameters and thresholds used
- Arbitrary trade-to-GDP join threshold applied: 2 percent for ratio of recorded total bilateral trade to GDP between country i and potential anchor j. Rationale: African bilateral trade-to-GDP averages are low; average bilateral trade-to-GDP ratio between any two African countries is about 0.59 percent.
- The analysis focuses on fundamentals (trade patterns and comovements of prices and outputs), setting standard convergence criteria (budget deficit, debt–to–GDP) aside.

### Inflation and variability overview (1960–2000 sample facts)
- Several countries experienced very high historical average inflation: Angola, Democratic Republic of the Congo, and Uganda had inflations ranging from 56 to 1,036 percent.
- Of 53 African countries:
  - 3 had average inflation rates above 50 percent.
  - 12 had average inflation rates above 20 percent.
  - 24 had average inflation rates exceeding 10 percent.
- Representative anchors’ average inflation (1960–2000):
  - West Africa CFA zone: approximately 5.5 percent.
  - Central Africa CFA (CAEMU): 7.5 percent.
  - Rand zone: 10 percent.
  - Nigeria (naira): about 18 percent.

### Dynamic bloc formation results — country-by-country moves (trade criterion = 2 percent)
- Using Nigeria as anchor:
  - Only Niger and Côte d’Ivoire meet the 2 percent threshold to join Nigeria. Given Nigeria’s relatively high inflation (~18 percent), Nigeria is not a good regional anchor under this scenario.
- Using Central African CFA zone (CAEMU) as anchor:
  - No country would join; highest trade share with CAEMU is about 1 percent.
- Using West African CFA zone (WAEMU) as starting point (individual country moves):
  - Early joiners: The Gambia, Mauritania, Liberia, Ghana, and Nigeria.
  - Average trade shares with WAEMU for these early joiners vary from 5.47 percent (The Gambia) to 2.29 percent (Nigeria).
  - Next potential joiners after forming this expanded bloc: Sierra Leone and Equatorial Guinea. Equatorial Guinea does not join because its trade share with CAEMU is 9.67 percent versus 2.14 percent with WAEMU+five countries.
  - Final bloc (WAEMU-based individual moves): WAEMU member countries plus The Gambia, Mauritania, Liberia, Ghana, Nigeria, and Sierra Leone. No other country joins because highest remaining trade share is Guinea with 1.86 percent.
- Using rand zone / Common Monetary Area (CMA) as starting point (individual country moves):
  - Early joiners (ten countries): Malawi, Mozambique, Zimbabwe, Zambia, Mauritius, Seychelles, Liberia, Comoros, Angola, and Tanzania.
  - Average trade shares with CMA for these vary from 21.42 percent (Malawi) to 2.23 percent (Tanzania).
  - Next joiners after expansion: Kenya, Botswana, São Tomé and Príncipe, Democratic Republic of the Congo, and Burundi, with trade shares from around 4 percent (Kenya) to 2.07 percent (Burundi).
  - Subsequent joiners: Uganda (5 percent), Rwanda (4.51 percent), Somalia (2.16 percent).
  - Djibouti then joins with trade share of more than 8 percent in the next round.
  - After this expansion no other countries satisfy the 2 percent criterion to join.
- Summary of country-move outcome:
  - Three blocs emerge from the country-level dynamic: (1) West African States bloc (WAEMU-centered), (2) Eastern and Southern Africa bloc centered on South Africa (rand/CMA-centered), and (3) existing Central Africa CFA zone (CAEMU).

### Dynamic bloc formation results — group moves (existing regional organizations)
- Recognizes overlapping and sometimes competing regional groupings; applies the trade threshold to existing regional groups (group moves) rather than to individual countries.
- Starting from WAEMU and applying group-move criterion:
  - The next mover would be the rest of ECOWAS (ECOWAS members not in WAEMU), with trade share 2.27 percent (see source Table 3a).
  - Once the ECOWAS currency bloc forms, the next mover according to the trade criterion would be Mauritania (which had formerly been a member but left ECOWAS).
- Group-move dynamics yield bloc configurations that differ slightly from country-move dynamics, reflecting path dependence and the importance of existing institutional/regional ties.

### Pattern, path dependence, and robustness
- The final bloc outcomes depend on the starting anchor (path dependence). Different starting points (Nigeria, WAEMU, CAEMU, CMA) yield different equilibria.
- The normative (model-based) analysis finds little economic justification for emergence of a single continental currency now; instead, it suggests multiple regional blocs.
- From a positive perspective (taking account of on-the-ground regional groupings and political realities), two large blocs could emerge partitioning sub-Saharan Africa into:
  - One bloc in West and Central Africa.
  - Another bloc around South Africa.
- The analysis acknowledges that accounting for ex post effects of currency union (trade increases after union) would reinforce countries that already join based on historical patterns, and would add some countries that would not join based solely on historical trade patterns. The positive analysis (which includes geographic, colonial, and institutional ties) captures some of these additional moves.

### Anchor choice and policy-relevant inference
- If a single African currency bloc were to occur, among major world currencies (dollar, euro, yen) the euro is identified as a good candidate anchor for the union (discussion noted; details in source).
- Caveat emphasized: decision to surrender national monetary policy ultimately transcends economic considerations; political will is crucial for currency union formation.
- The paper focuses on fundamentals (trade and comovements) and notes that standard convergence criteria (budget deficit, debt–to–GDP) can be met subsequently by fiscal discipline once fundamentals align.

*Italic source attribution: Excerpt from "Dynamic Currency Bloc Formation Based on the Moves of Existing Regional Groups" (section 3) of the provided IMF working paper content.*

### 1999. Continuing the process, the next group with the highest trade share with the bloc

### _wp0545 - 1999. Continuing the process, the next group with the highest trade share with the bloc

### Formation of currency blocs and trade-share thresholds
- CAEMU (Central African CFA zone) has a trade share of only 1.51 percent with ECOWAS and Mauritania.
- The threshold for joining the bloc is 2 percent; CAEMU does not meet this threshold and therefore should not join on that criterion.
- CAEMU already shares the same currency with WAEMU; both CFA zones issue their own CFA franc, each with its own central bank, and both are pegged to the French franc (now the euro).
- Geographically, Nigeria separates the two CFA zones; if WAEMU and other West African States including Nigeria formed a currency union, CAEMU would be compacted with WAEMU and there would be no reason for CAEMU not to join—hence the analysis uses a dashed link between CAEMU and ECOWAS and Mauritania in Figure 3.

- Starting from the CMA (part of SADC):
  - The rest of SADC country members have the highest trade share with CMA at 7.04 percent; they join CMA to form a larger SADC currency bloc.
  - The group formed by the remaining CBI member countries has the highest trade share with the SADC currency bloc at 2.53 percent; they join, creating a bloc comprising all SADC and CBI member countries.
  - São Tomé and Príncipe, not a member of SADC or CBI, has a trade share of 4.04 percent, which exceeds the 2 percent threshold and therefore might also join the SADC+CBI bloc.
  - No other group meets the criteria to join the SADC, CBI, and São Tomé and Príncipe currency bloc.

- Resulting partition:
  - Two large blocs emerge: one in western and central Africa, the other in eastern and southern Africa.
  - Almost the entire sub-Saharan Africa partitions into these two blocs.
  - Exceptions retaining individual currencies include Djibouti, Ethiopia, Eritrea, and Sudan (along with North African countries).

### Comovements of prices and outputs (evidence supporting bloc formation)
- Measures of comovements of prices (Tables 4a and 4b) follow the dynamics generated by trade; lower numbers indicate more comovement.
- Observations on price comovement:
  - CFA zone country members (who share the same currency) have a high degree of price comovement.
  - Some North African countries (Tunisia, Morocco, Algeria) have relatively high price comovements with the ECOWAS bloc, suggesting some justification for joining a sub-Saharan currency bloc.
  - The rand zone country members have a high degree of price comovement.
  - Early joiners to CMA, such as Botswana and Mauritius, have relatively high price comovements with CMA.

- Measures of comovements of outputs (Tables 5a and 5b) show a picture broadly similar to prices:
  - CFA zone members have relatively high comovement of outputs.
  - Some non-CFA countries (Kenya, Algeria, Egypt) comove better in outputs with WAEMU.
  - Rand zone members also have relatively high comovement of outputs.
  - Early joiners to CMA/Waemu often perform better in output comovement.

- Specific comovement figures and examples:
  - Ghana and Nigeria exhibit a lack of price comovements of the order of 31 and 38 percent respectively.
  - Ghana and Nigeria exhibit a lack of output comovement only of the order of 6 percent each.
  - Guinea-Bissau performed poorly in price and output comovements with WAEMU because it joined the union only in 1997.

### Caveats, interpretation, and theoretical context
- Trade alone may not unambiguously imply stronger comovements of prices and outputs.
  - Frankel and Rose (1998) argue that more trade leads to more correlated business cycles.
  - Krugman (1993) argues that more trade can lead to greater sectoral specialization and thus lower comovements.
  - Theory predicts intra-industry trade tends to increase comovements, while inter-industry trade tends to reduce them by producing industry-specific (country-specific) shocks.
  - Intra-African trade exhibits very little intra-industry trade, which may explain low price and output comovements for some countries.

### Conclusions and political considerations
- The analysis finds no evidence for the emergence of a single continental currency in Africa under the applied trade-share and comovement criteria.
- A single continental currency could nonetheless emerge; the decision to surrender monetary policy to a supranational institution extends beyond economic criteria and involves political considerations.
- The study’s configuration and normative/positive arguments leave the single-currency outcome unclear despite the African Union’s aspirations.

*Source: _wp0545 - 1999. Continuing the process, the next group with the highest trade share with the bloc*

### introduction of the euro, most studies concluded that the European Union was unsuitable for a

### _wp0545 - introduction of the euro, most studies concluded that the European Union was unsuitable for a

### V. Currency bloc in Africa: a potential anchor
- Purpose: Investigate which major currency—the dollar, euro or the yen—would be the best anchor for an African currency union.
- Rationale: Small, open economies transact the bulk of international commerce and finance in advanced industrial nations’ currencies; an African currency union may need a major-currency anchor to commit to anti-inflationary policy.
- Empirical computation: For the African Union, the average trade–to–GDP ratio with major currency blocs (dollar, euro, yen) was computed.
- Key statistic:
  - Africa’s trade share with the European Economic and Monetary Union (EMU): 22.15 (In percent)
  - Africa’s trade share with the United States: 6.95 (In percent)
  - Africa’s trade share with Japan: 2.42 (In percent)
  - If the United Kingdom were to join the EMU (Europe–13), the EMU share would rise to 26.67 (In percent)
- Conclusion from this section: The euro seems to be a good choice of anchor for the African Union based on trade shares.

### VI. Conclusions
- Twofold basic message:
  - Path dependence and trade network externalities:
    - Currency bloc formation is path dependent.
    - Trade network externalities help explain gradual expansion of currency blocs (framework developed in Yehoue, 2004).
    - Empirical evidence (historical data on inflation, trade, comovements of prices and outputs) suggests emergence of currency bloc(s) in Africa will follow a gradual path and does not imply a single continental currency at this time.
    - The emergence of an African currency union is not precluded; ultimate decisions to surrender national monetary policy involve political will and go beyond purely economic considerations.
  - Choice of anchor:
    - Were an African Monetary Union to emerge and opt for anchorage, analysis suggests the euro would be a good anchor.

### Empirical findings: Inflation, volatility, and trade patterns (selected highlights from tables)
- Mean annual inflation rate, 1960–2000 (GDP deflators) — selected high-inflation countries (In percent):
  - Congo, Dem. Rep. of: 1036.22
  - Angola: 819.68
  - Uganda: 55.76
  - São Tomé and Príncipe: 42.35
  - Mozambique: 36.77
  - Ghana: 28.33
  - South Africa: 10.31
  - Morocco: 5.12
  - Cape Verde: 4.53
- Inflation rate variability (standard deviation of annual inflation rates, 1960–2000) — selected high-variability countries (In percent):
  - Congo, Dem. Rep. of: 4480.18
  - Angola: 1467.90
  - Uganda: 63.33
  - Somalia: 44.44
  - Zambia: 40.26
  - Cape Verde: 2.20
  - Djibouti: 1.94
- Trade-to-GDP ratios (average, 1980–2000) — selected country moves and blocs (In percent):
  - Country moves from Nigeria — Niger: 4.34; Côte d'Ivoire: 3.72; WAEMU: 2.49; CMA and WAEMU and CAEMU: 3.18
  - Country moves from CAEMU — Senegal: 1.22; Guinea: 1.04; WAEMU: 0.56; CMA and WAEMU and Group of five: 0.89
  - Country moves from WAEMU — Gambia, The: 5.47; Mauritania: 5.22; Liberia: 4.22; Nigeria: 2.29
  - Country moves from CMA — Malawi: 21.42; Mozambique: 19.46; Zimbabwe: 14.61; Zambia: 11.31; Kenya (with expanded CMA list): 3.86; Djibouti: 8.13
- Regional group trade-to-GDP highlights (1980–2000) (In percent):
  - WAEMU: ECOWAS Rest: 2.27; Group of 5: 2.21; CAEMU: 0.74
  - CMA: SADC (Rest): 7.04; CBI (Rest): 1.24; WAEMU: 0.40
- Price comovement measures (CP) — lower CP implies greater comovement (1960–2000):
  - Price comovement following trade dynamic from WAEMU — selected CP values:
    - Senegal: 0.04; Niger: 0.04; Mali: 0.04; Benin: 0.05; Nigeria: 0.38; Sudan: 0.48
  - Price comovement following trade dynamic from CMA — selected CP values:
    - Lesotho: 0.04; South Africa: 0.05; Botswana: 0.08; Nigeria: 0.38; Sudan: 0.50
  - Price comovement following trade dynamic from CMA with SADC — selected CP values:
    - Morocco: 0.07; Tunisia: 0.07; Nigeria: 0.37; Sudan: 0.49
- Output comovement measures (CY) — lower CY implies greater comovement (1960–2000):
  - Output comovement following trade dynamic from WAEMU — selected CY values:
    - Kenya: 0.03; Algeria: 0.04; Egypt: 0.04; Côte d'Ivoire: 0.05; Nigeria: 0.06; Rwanda: 0.11
  - Output comovement following trade dynamic from CMA — selected CY values:
    - South Africa: 0.04; Ghana: 0.04; Zambia: 0.05; Madagascar: 0.05; Nigeria: 0.07; Rwanda: 0.12
  - Output comovement following trade dynamic from CMA with SADC — selected CY values:
    - Kenya: 0.04; Benin: 0.04; Nigeria: 0.07; Rwanda: 0.12

### Methodological appendix (computation of comovements)
- Relative output/comovement computation:
  - For each country pair (i, j), use annual series 1960–2000 of relative per capita GDP ln(Yit/Yjt).
  - Fit AR-2 regression: ln(Yit/Yjt)t = a0 + a1 ln(Yit/Yjt)t-1 + a2 ln(Yit/Yjt)t-2 + εtij.
  - Measure of lack of comovement of relative output: CYij = sqrt( (1/(T-3)) * Σt εtij^2 ). The lower CYij, the greater output comovement.
- Relative price/comovement computation:
  - Analogous AR-2 regression for ln(Pit/Pjt) yielding residual utij.
  - Measure of lack of comovement of relative prices: CPij = sqrt( (1/(T-3)) * Σt utij^2 ). The lower CPij, the greater price comovement.
- Data constraints:
  - Fewer observations used when full 1960–2000 series not available.
  - Country-pairs with fewer than 18 observations are dropped.

### Policy-relevant implications and interpretive points
- Trade orientation matters for anchor choice: with Africa’s largest trade share toward EMU (22.15 percent; 26.67 percent if UK is included), the euro appears the most natural external anchor for an African union seeking anti-inflationary credibility.
- Gradualism: empirical evidence supports gradual emergence of currency blocs in Africa rather than an immediate continental currency.
- Political will: success of any currency union depends critically on political decisions to cede national monetary policy to a supranational institution; economics alone do not determine union formation.

*Source: _wp0545 - introduction of the euro, most studies concluded that the European Union was unsuitable for a (PDF chapter/section).*

### REFERENCES

### _wp0545 - REFERENCES

### Foundational theoretical works on Optimum Currency Areas and monetary unions
- Mundell, Robert, 1961, “A Theory of Optimum Currency Areas,” American Economic Review, Vol. 51 (November), pp. 657–65.
- Bayoumi, Tamin, 1994, “A Formal Model of Optimal Currency Areas,” Staff Papers International Monetary Fund, Vol. 41 (December), pp. 537–54.
- Alesina, Alberto, and Silvana Tenreyro, 2002, “Optimal Currency Areas,” in NBER Macroeconomic Annual, ed. by Mark Gertler and Kenneth Rogoff (Cambridge, Massachusetts: MIT Press).
- Devarajan, Shanta, and Jaime de Melo, 1987, “Evaluating Participation in African Monetary Unions: A Statistical Analysis of the CFA Zones,” World Development, Vol. 15 (April), pp. 483–96.
- de Grauwe, Paul, and Wim Vanhaverbeke, 1993, “Is Europe an Optimal Currency Area? Evidence from Regional Data,” in Policy Issues in the Operation of Currency Unions, ed. by Paul Masson and Mark P. Taylor (Cambridge, England: Cambridge University Press).
- von Hagen, Jurgen and Manfred J. M. Neumann, 1994, “Real Exchange Rates Within and between Currency Areas: How Far is EMU?”, The Review of Economics and Statistics, Vol. 76 (May), pp. 236–44.

### Empirical and econometric studies on currency unions and trade effects
- Frankel, Jeffrey, and Andrew K. Rose, 1998, “The Endogeneity of the Optimum Currency Area Criteria,” Economic Journal, Vol. 108 (July), pp. 1009–25.
- Frankel, Jeffrey, 2002, “An Estimate of the Effect of Common Currencies in Trade and Income,” Quarterly Journal of Economics, Vol. 117 (May), pp. 437–66.
- Rose, Andrew K., 2000, “One Money, One Market: Estimating the Effect of Common Currencies on Trade,” Economic Policy, Vol. 15 (April), pp. 9–45.
- Glick, Reuven, and Andrew K. Rose, 2002, “Does a Currency Union Affect Trade? The Time Series Evidence,” European Economic Review, Vol. 46 (June), pp. 1125–51.
- Broda, Christian, 2004, “Terms of Trade and Exchange Rate Regimes in Developing Countries,” Journal of International Economics, Vol. 63 (May), pp. 31–58.
- Barro Robert J., and Silvana Tenreyro, 2003, “Economic Effects of Currency Unions,” NBER Working Paper No. 9435 (Cambridge, Massachusetts: National Bureau of Economic Research).

### Political economy and institutional perspectives on monetary integration
- Alesina, Alberto, and Vittorio Grilli, 1992, “The European Central Bank: Reshaping Monetary Politics in Europe,” in Establishing a Central Bank: Issues in Europe and Lessons from the US, ed. by Matthew Canzoneri, Vittorio Grilli, and Paul Masson (Cambridge, England: Cambridge University Press).
- Feldstein, Martin, 1997, “The Political Economy of the European Economic and Monetary Union: Political Sources of an Economic Liability,” Journal of Economic Perspectives, Vol. 2 (Fall), pp. 23–42.
- Cohen, Benjamin J., 2003, “Monetary Union: The Political Dimension,” in The Dollarization Debate, ed. by James W. Dean, Dominic Salvatore, and Thomas D. Willett (Oxford: Oxford University Press).
- Cohen, Benjamin J., 1993, “Beyond EMU: The Problem of Sustainability,” Economics and Politics, Vol. 5 (July), pp. 187–202.
- Krugman Paul, 1993, “Lessons of Massachusetts for EMU,” in The Transition to Economic and Monetary Union in Europe, ed. by Francisco Torres and Francesco Giavazzi (Cambridge, England: Cambridge University Press).

### Regional studies: Europe, Africa, and Southern Africa integration
- Eichengreen, Barry, 1993, “European Monetary Unification,” Journal of Economic Literature, Vol. 31 (September), pp. 1321–57.
- Masson, Paul, and Catherine Pattillo, 2001, Monetary Union in West Africa (ECOWAS): Is It Desirable and How Could It Be Achieved? IMF Occasional Paper No. 204 (Washington: International Monetary Fund).
- Ogunkola E. Olawale, 2000, “Evaluation of the Viability of a Single Monetary Zone in ECOWAS,” A final Report presented at the Biannual Research Workshop of the African Economic Research Consortium, (AERC), Nairobi, Kenya.
- Ogunkola E. Olawale, 2002, “The Second Monetary Zone in West Africa and the Future of a Single Monetary Zone in sub-Saharan Africa” (unpublished, National University of Lesotho).
- Devarajan, Shanta, and Jaime de Melo, 1987, “Evaluating Participation in African Monetary Unions: A Statistical Analysis of the CFA Zones,” World Development, Vol. 15 (April), pp. 483–96.
- Sparks, Donald L., 2002, “The Future of Monetary Integration in Southern Africa: Will SADC Join the Rand Monetary Area?” (unpublished; Toronto: Ryerson University).
- Economic Community of West African States (ECOWAS), 1980, Unrecorded Trade Flows within ECOWAS, Report prepared for ECOWAS Trade Customs and Monetary Study Project by the United Nations Economic Commission for Africa and the Economic and Social Council, E/CN.14, Working Paper 1/115.
- Foroutan, Faezeh, and Lant Pritchett, 1993, “Intra Sub-Saharan African Trade: Is It Too Little?” Journal of African Economies, Vol. 2 (May), pp. 74–105.
- Devarajan, Shanta, and Jaime de Melo, 1987, “Evaluating Participation in African Monetary Unions: A Statistical Analysis of the CFA Zones,” World Development, Vol. 15 (April), pp. 483–96.

### Studies on currency-area dynamics, sustainability, and network effects
- Alesina, Alberto, and Robert J. Barro, 2002, “Currency Unions,” Quarterly Journal of Economics, Vol. 117 (May), pp. 409–36.
- Barro Robert J., and Silvana Tenreyro, 2003, “Economic Effects of Currency Unions,” NBER Working Paper No. 9435 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Yehoue, Etienne B., 2004, “Currency Bloc as a Dynamic Process Based on Trade Network Externalities,” IMF Working Paper 04/222, (Washington: International Monetary Fund), November.
- Broda, Christian, 2004, “Terms of Trade and Exchange Rate Regimes in Developing Countries,” Journal of International Economics, Vol. 63 (May), pp. 31–58.
- Frankel, Jeffrey, 1997, Regional Trading Blocs in the World Economy (Washington: Institute for International Economics).

*Source: _wp0545 - REFERENCES*

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