Download Is WAMZ an Optimum Currency Area (OCA)?

Is WAMZ an Optimum Currency Area (OCA)?
Tamsir Cham20
Abstract
This paper assesses the feasibility of West African Monetary Zone (WAMZ) in forming a common
currency using Macroeconomic convergence and Optimum Currency Area (OCA) criteria. We seek to
answer the question: Does WAMZ meet the Macroeconomic convergence and OCA criteria? We use
the same benchmark criteria that were used by European Monetary Union (EMU). In addition, in
most of our analysis, we used the existing monetary union -West Africa Economic and Monetary
Union (WAEMU) as a comparison zone. The empirical analysis revealed that the zone does not meet
the Macroeconomic convergence criteria. We then examined the OCA criteria. Out of the three
optimum currency area criteria considered i.e. openness, synchronization of shocks, and labor
mobility, the zone did well in openness criterion. However, labor mobility within the zone is
relatively low and shocks are not uniform. Consequently, we concluded that the zone failed to meet
the OCA criteria as well. However WAMZ member countries have made some progress in meeting the
required criteria. Since 2007 all WAMZ member countries have shown a single digit inflation rate.
Both inflation and debt-to-GDP figures show a downward trend since 2005.
JEL Classification Codes: E31, E41, E42, F22, F33, F41
Keywords: Macroeconomic convergence, Optimum Currency Area, Openness, Inflation, Labor
mobility, WAMZ
The adoption of the euro by the European Monetary Union (EMU) and its successful
launching in January 1999 has stimulated interest in the formation of currency union
arrangements around the globe. Prior to the euro, other currency unions have been in
existence, including the Central Africa Economic Monetary Union (CAEMU), the West
African Economic Monetary Union (WAEMU), the Eastern Caribbean Currency Union
(ECCU), and the Common Monetary Authority (CMA).
Monetary integration in West Africa is one of the programs of the Economic Community
of West African States’ (ECOWAS) agenda. ECOWAS Monetary Cooperation Program
(EMCP) was established in 1987 with the intention to form one monetary zone and one
20
The author is the Director of Economic Management and Planning Unit at The Ministry of
Finance & Economic Affairs, Banjul, The Gambia. The author can be contacted at
[email protected] , Tel: (+220) 9338289, Fax: (+220) 4228551. I am grateful to Dr. Ransford W.
Palmer, Dr. Joseph Augustine, Dr. Satish Wadhawan, Dr. Wayne Patterson, Dr. Rupert DeLisle
Worrell, Dr. William Spriggs, Dr. Micheal Ojo, Serign Cham, Ndiama Diop, Djibrilla Issa, and Deo
Ndikumana, for their comments and suggestions. I am also grateful to Mrs. Absa Jobe-Sallah, for
providing me with data. All errors or interpretations remain mine.
common currency in the sub-region. Recently, five West African countries decided to form
a monetary union. This monetary union zone is called the West African Monetary Zone
(WAMZ)21. It will be the second monetary union within ECOWAS. As discussed in WAMI
(2005), the target date was 2005, but the date has now been deferred to December 2009 to
give room for countries to be better prepared for a full-fledged monetary union. By forming
a common currency, the zone can benefit from enhanced trade, investment, fiscal
discipline, economic growth, price stability; reduced inflation level and macroeconomic
stability.
The ECOWAS zone mainly consists of Francophone and Anglophone countries. 22 The
Francophone countries established a monetary union in 1948. The CFA zone has shown
commitment to a fixed exchange rate by irrevocably fixing the CFA franc to the French
franc at fixed parity23. This paper examines whether WAMZ member countries meet the
macroeconomic convergence criteria. It also seeks to answer the question: Is WAMZ an
optimum currency area (OCA)?
This paper differs from earlier studies in the following: First, it goes beyond the standard
method of assessing convergence criteria using budget deficit and debt-to-GDP ratio. Second
the paper examines co-movement of prices, GDP, terms of trade, current account and not
pattern of currency bloc24. Consequently, the paper looks at the existing traditional
convergence criteria, the average co-movements of these variables and the evolution of these
variables overtime. The paper also seeks to compare the behavior of these variables with the
existing currency union in West Africa – WAEMU. The major limitation of the paper is
that we go not look into intra regional trade and trade intensity for the zone. Hence
currency union (WAMZ) potential impact on trade is beyond the scope of the paper which
can be a good area of research.
This paper is organized as follows: In section 2, the feasibility of WAMZ from
macroeconomic convergence criteria is examined; in Section 3, OCA criteria and whether
WAMZ constitutes OCA; Section 4 contains the data sources, methodology, and empirical
results. Section 5 concludes the paper.
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22
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24
The five countries are The Gambia, Ghana, Guinea, Nigeria, and Sierra Leone.
And two countries Guinea-Bissau and Cape Verde colonized by the Protégées.
The fixed parity was altered only once in 1994.
See Yehoue 2005
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MACROECONOMIC CONVERGENCE REQUIREMENTS
According to European Union Commission (1990), monetary union requires virtually
complete convergence of economic variables. Monetary union, however, accommodates
regional divergences in relative wage levels that arise as a result of differences in
productivity and competitiveness. Charalambos Tsangarides and Mahvash Saeed Qureshi
(2005) reviewed the literature on convergence and OCA using cluster analysis to assess the
readiness and sustainability of monetary union by classifying West African countries into
groups according to their performance towards achieving the OCA and convergence criteria
for common currency adoption. Their results revealed that inflation is higher in WAMZ
than WAEMU zone. They also concluded that debt-to-GDP has been steadily declining over
the years in WAMZ zone. Xavier Debrun, Paul Masson and Catherine Pattillo (2002)
surveyed OCA to analyze the costs and benefits of the proposed monetary union using a
simple theoretical framework calibrated to reflect some of the region’s key economic and
political features. They assessed the net gainers and losses based on the correlation of shocks
to the terms of trade (TOT). Yehoue (2005) examined whether empirical investigation
points to the gradual emergence of currency blocs in Africa.
As discussed in De Grauwe (2003), in situations where countries are catching up in levels of
productivity and income, there will as a result be some margin for consumer prices on
average to rise a little faster than in the community as a whole as the prices of non-tradable
services converge on the levels found in high income countries. Budget balances and
current account balances can diverge even more substantially. The essential requirement for
budgetary policy is sustainability of the public debt without resorting to monetary
financing. Consequently, it is important that a reasonable degree of convergence of price
inflation and reduction of excessive budget deficits are achieved before the irrevocable
fixing of the exchange rates. The convergence of price, cost performance, and budgetary
policies, however, will be strongly influenced by the credibility of commitments to a given
future monetary regime, so long as the time-horizon is not too long. For this reason,
commitments to the later stages of monetary union should not be held up until the
ultimately required degree of convergence is achieved. Consequently lack of commitment
and not leveling the playing field i.e. failure to put macroeconomic fundamentals in order,
will make the sustainability of the monetary union unattainable.
Since WAMZ is characterized on the one hand by imperfect economic integration and on
the other hand by a single monetary policy, the question arises as to what degree of price,
and more generally macroeconomic convergence, is required for the stability of the zone?
Currently, inflation can frequently diverge in the short run by few percentage points. In the
long run however, price inflation does not have to diverge by more than a fraction of one
percentage point per year across countries. In addition, member countries should retain
autonomy regarding short-run budgetary policy. However, excessive deficits that lead to
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exploding public debts are not compatible with monetary union, essentially because the
policy of price stability might be put at risk if individual countries run up excessive public
debts or deficits. Therefore, proper coordination of fiscal policies among member states is
required.
According to European Commission (1990), the well-functioning of a monetary union is
not limited to macroeconomic convergence of its member countries. An effective
management of macroeconomic policy for the union requires the convergence in policy
preferences, or at least agreement on the policy objectives, and therefore on the weighting of
targets and choice of instruments of economic policy.
Given that meeting macroeconomic convergence criteria is the centerpiece for entry into
monetary union, and guarantee of its smooth functioning, member countries must attain
and comply with certain target requirements that need to be satisfied before and after the
monetary union launches. According to the European Commission (1990), certain
conditions are outlined in a monetary convergence as essential for the successful launching
and sustaining of a monetary union.25 These conditions are as follows: First, the inflation
rate for WAMZ members should be almost 5 percentage points. A country joining a
monetary union must be within 1.5 percentage points of the average of the three lowest
inflation rates within the zone; second, the long-term interest rate of the country joining
the single currency must not exceed by more than 2 percentage points of the interest rates
observed in the three countries with the lowest inflation rates, on the grounds that high
long-term rates reflect high expected inflation; third, the exchange rate must have remained
within the normal bands of the existing WAMZ without severe tensions for at least two
years. The other conditions relate to fiscal policy in that the debt-to-GDP ratio (debt/GDP)
should not exceed 60 percentage points and deficit-to-GDP ratio (deficit/GDP) should be 5
percent or less.26 In addition to meeting the macroeconomic convergence criteria, the zone
needs to satisfy the Optimal Currency Area criteria that are discussed in the next section.
IS WAMZ AN OPTIMAL CURRENCY AREA (OCA)?
A common currency bloc is a region where a single currency or basket of currencies pegs to
a currency which circulates and is freely accepted in the region. It is a region where a single
supranational central bank conducts monetary policy. It also takes the form where all the
values of monetary units are fixed in relation to one another. The functioning of common
currency requires that the exchange rate within the region is fixed in relation to one
another but varies in relation to other countries or regions outside the currency bloc. It is
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WAMZ modified the European Union convergence criteria.
See WAMI (2005)
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widely accepted that in a monetary union arrangement, only one single central bank
manages the pool of reserves and issue currency.
According to discussions by Mundell (1961), Mckinnon (1963), Kenen (1969), Ghosh
(1994), Frankel and Rose (2000), Alesina, Barro, Tenreyro (2002), and others, an OCA
constitutes economies that are affected systematically by disturbances. It is an area where all
the regions within the area face similar kinds of economic shocks and labor is freely mobile
within the area. Whether a region adopting a common currency satisfies the OCA criteria
or not has not been discussed at length in the economic literature. The optimum currency
area literature asserts that meeting OCA criteria are necessary and sufficient conditions
under which two or more countries can share the same currency without an adverse effect.
This assertion is grounded with the assumption that nominal exchange rates are very
effective; otherwise it is meaningless for a country to abandon its own currency. The
exchange rate can serve as a major macroeconomic stabilizer in that it affects relative prices
of traded goods, non-traded goods, or the ratio of exports to imports, and real wages that
are paid to workers by producers. Consequently, for a country or group of countries to
enter into monetary union there need to be certain conditions that make the functioning of
nominal exchange rate less appealing.
According to Mundell (1961), Mckinnon (1963), Kenen (1969), Euperan Union
Commission (1990) three criteria need to be satisfied for a region to be considered an
Optimum Currency Area. The three main criteria are well articulated in the optimum
currency area literature. The first criterion is mutual openness to trade. The greater a region
is open to trade the less effective the nominal exchange rate is since most prices are
determined at the regional level which makes nominal exchange rate relatively ineffective in
altering relative price ratios. The second criterion discussed is the diversification of
individual economies. The more diversified an economy is, the less it suffers from
economic shocks. The last but not the least criterion is the mobility of inputs, particularly
labor. The more mobile labor is in a region forming a monetary union, the less the effect of
adverse shocks on an economy since labor can migrate from the affected area to the
unaffected area. The ease in mobility of labor lessens the need for an exchange rate to act as
an adjustment mechanism. These criteria will be examined within the context of WAMZ
zone to evaluate the extent to which it satisfies these criteria. This section provides an
answer to the following question: Is WAMZ an OCA?
Robert Mundell (1961) the pioneering Nobel Prize winner, was the first to articulate the
idea of OCAs where the cost associated with currency union membership would be
reduced. According to Mundell (1961), optimality relates to the condition of labor market.
He argued that if the prevailing exchange rate regime, either fixed or flexible, can maintain
external balance without causing unemployment or demand induced inflation, then that
regime is optimal. Mundell (1961) further asserted that if a currency regime within a given
area causes unemployment somewhere in that area or force some other portion of the same
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area to accept inflation as a remedy to unemployment, then it is not optimal. 27 Mundell
contends that interregional factor mobility can substitute for changes in regional exchange
rates, and that the entire zone through which labor can move freely defines the right
domain for a monetary union. With labor mobility, the two regions comprise an optimum
currency area.
Subsequently, others surveyed the literature and developed arguments based on Mundell’s
work. Among the most renowned authors in the field are Mckinnon (1963) and Kenen
(1969). Mckinnon’s work was a continuation of Mundell’s but proposed further
requirements that there needed to be high intra-area trade within the region. He described a
single currency area as an area where monetary-fiscal policy and flexible external exchange
rates can be used to give the best solution of three mutually exclusive objectives of
monetary policy.28
Kenen (1969) built on Mundell’s work but emphasized the need for an economically
diversified area with potent fiscal policy at its disposal. However, he claimed that Mundell’s
definitions were more implicit than explicit as they relate to the delineation of an economic
region.
A large body of research developed from the earlier discussions of Mundell, Mickinnon and
Kenen. All researchers centered on one of the following three criteria: openness,
diversification of individual economies, and mobility of inputs across the area - labor in
particular. Some researchers surveyed risk of country specific shocks. One set of study
examines co-movements of key macroeconomic variables like the GDP, unemployment,
inflation, or current account balances across European countries (Cohen and Wyplosz,
1989). Other studies compare shocks across regions with shocks across countries (De
Grauwe and Vanhaverbeke, 1993; Von Hagen and Neumann, 1994).
27
According to Mundell, a currency area comprising different countries with national currencies the
pace of employment in deficit countries is set by the willingness of surplus countries to inflate. But in
a currency area comprising many regions and single currency, the pace of inflation is set by
willingness of the central authorities to allow unemployment in deficit regions. But a currency area of
either type cannot prevent both unemployment and inflation among members. The fault lies not with
the type of currency area, but with the domain of the currency area. The optimum currency area is
not the world.
28 The following are the conflicting objectives: attainment of full employment, maintenance of
balance of payment and internal price stability.
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For the input mobility criterion, studies have shown that labor in Europe is not as mobile
as in the United States. Blanchard and Katz (1992) find that in United States when a
particular region is hit by an adverse shock, a large proportion of the subsequent drop in
employment is matched by labor migration. Krugman (1993) inferred that economic
integration leads to increased regional specialization. Frankel and Rose (1998) empirically
rejected Krugman’s conjecture as they find that integration leads to more diversification. As
a consequence, the optimum currency area criteria are endogenously determined.
Alesina and Barro (2002) have extended Mundell’s (1961) analysis. All their work focused
on the trade-off between the costs and benefits of monetary unions. Their work attempted
to size Europe up against the Mundell-Mckinnon-Kenen criteria. In summary, the criteria:
factor mobility (Mundell, 1961), trade integration (Mckinnon, 1963), and a similar regional
production pattern (Kenen, 1969), constitute an optimum currency area. Masson, Pattillo
(2004, 2002, 2001) surveyed the literature of the optimum currency area to investigate the
monetary geography of West Africa, the feasibility of a single currency for Africa and a
monetary union for ECOWAS member countries.
Debrun, Masson and Pattillo (2002) assessed the feasibility of WAMZ to investigate the
winners and losers. Their study revealed Nigeria being the only gainer while the rest
(Gambia, Ghana, Guinea, and Sierra Leone) are losers. Devarajan and de melo (1987)
conducted a study on CFA countries in West Africa. They used a statistical analysis
approach to assess the benefits of participating in a monetary union. In the next section, I
examine whether WAMZ zone satisfies the macroeconomic convergence and OCA criteria.
DATA, METHODOLOGY AND RESULTS
Data Source
Interest rate and exchange rate data are extracted from the International Monetary Fund’s
International Finance Statistics (IFS). Data on debt and deficit as a percentage of GDP are
obtained from West African Monetary Institute (WAMI) Data base. Real output data was
extracted from WAMI Data base. These data are expressed in US dollars using 2000 as the
base year. Time series with yearly data on outputs from 1980 to 2005 are used. For countries
that have fewer observations due to unreported data, a relatively shorter period is used.
Inflation, exports, imports, investment, current account balance, and terms of trade data are
also extracted from International Monetary Fund’s International Finance Statistics (IFS) via
WAMI. Bilateral trade data is sourced from World Bank’s World Development Indicators
(WDI). We used trade data for the period 1980 to 2005. These data are expressed in US
dollars.
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Methodology
Macroeconomic Convergence
To compute the inflation rate criteria, we used consumer price index (CPI) as a measure of
inflation. We first compute the mean inflation from 1980-2005 and also considered
inflation rate of individual countries from 2000-2005. Average inflation of a country is the
total inflation divided by the number of observations. We then computed the average of the
three countries with lowest inflation rate in WAMZ zone and multiplied the result by 1.5
percent to determine whether the countries with higher inflation rate demonstrate the
tendency of meeting such criterion. The long-term interest rate criterion is also assessed.
The average of the three best performing countries in terms of price stability is computed.
The long-term interest rate of a zone member should not exceed 2 percent of the computed
average. For the exchange rate requirement, we took the annual growth rate of the respective
countries’ exchange rate relative to the U.S. dollar to assess the variability of individual
countries’ exchange rate vis-à-vis the US dollar. We used the US dollar because it is the most
widely used international currency and most trade in the region involved the US dollar. We
used 2005 debt and deficit GDP ratio to assess whether WAMZ member meet fiscal policy 29
criterion. These ratios assess whether WAMZ member countries are within the required
thresholds in terms of debt and or deficit GDP ratios.
To compute trade share for each country, we used trade data and real GDP from WDI.
Country trade share is the ratio of bilateral trade to real GDP. Trade is calculated as export
plus imports and trade share is the ratio of trade to GDP. Since accurate trade data is
difficult to obtain, we followed Yohoue (2004) and computed bilateral trade between two
countries as the average trade reported by the two countries.
29
Debt-to-GDP and deficit-to-GDP ratios
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Optimum Currency Area
The computation of Openness
Openness is defined as exports plus imports as a share of GDP. To compute individual
countries’ relative openness, we added an individual country’s exports and imports and
divided the results by the GDP30. Openness is measured as the ratio of the sum of exports
and imports to GDP given by
Openness 
exp orts  imports
GDP
The Computation of Co-movements31
To compute the co-movements, we followed Alesina, Barro, and Tenreyro (2002) and
Yehoue (2004), paired all countries and computed the relative output Yit Y jt . For every
pair (i, j ) , we used the annual time series {
Yi ,t
Y j ,t
}t2005
1980 of the relative per capita GDP, to
compute the second-order auto regression.
ln
Yi ,t
Y j ,t
 a0  a1 ln
Yi ,t 1
Y j ,t 1
The estimated residual,
ˆtij
 a 2 ln
Yi ,t 2
Y j ,t  2
  tij
measures the relative output per capita GDP that would not be
predictable from the two prior values of relative output. To measure lack of output comovement of relative output, the root-mean-squared error is used given as:
MYij 
1 T 2
 ˆtij
T  3 t 1
Where a lower value of MYij , the greater the co-movement of output between the two
countries i and j .
30
This is contrary to formula used by Wyplosz (1997), where openness is measure as a ratio exports to
GDP
31 I follow Wyplosz et al to measure shock.
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Using the same procedure, the inflation co-movement is computed. The value M ij comes
from the estimated residuals from the second-order auto-regression on annual data for
relative inflation:
ln
 i ,t
 i ,t 1
 i ,t  2
 c0  c1 ln
 c2 ln
 vtij
 j ,t
 j ,t 1
 j ,t  2
The estimated residual v̂tij , measures the relative inflation rate that would not be predictable
from the two prior values of the relative inflation rate. Co-movement of relative inflation
rate is measure by using root-mean-square error:
1 T 2
 vˆtij
T  3 t 1
M ij 
The lower the value of M ij , the greater the co-movement of inflation between the two
countries i and j .
Similarly, we computed the current account balance co-movement. The value MCAij comes
from the estimated residuals from the second-order auto-regression on annual data for
relative current account balance:
ln
CAi ,t
CA j ,t
 b0  b1 ln
CAi ,t 1
CA j ,t 1
 b2 ln
CAi ,t 2
CA j ,t 2
 wtij
The estimated residual ŵtij , measures the relative current account balance that would not be
predictable from the two prior values of the relative current account balance. Co-movement
of the relative current account balance is measure by using root-mean-square error:
MCAij 
1 T 2
 wˆ tij
T  3 t 1
The lower the value of MCAij , the greater the co-movement of current account balance
between the two countries i and j .
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Using the same method, we compute the terms of trade co-movement. The value
MTij comes from the estimated residuals from the second-order auto-regression on annual
data for relative terms of trade:
ln
Ti ,t
T j ,t
 d 0  d1 ln
Ti ,t 1
T j ,t 1
 d 2 ln
Ti ,t  2
T j ,t  2
 z tij
The estimated residual ẑtij , measures the relative terms of trade that would not be
predictable from the two prior values of the relative terms of trade. Co-movement of the
relative terms of trade is measured by using root-mean-square error:
MTij 
T
1
2
zˆ tij

T  3 t 1
The lower the value of MTij , the greater the co-movement of terms of trade between the
two countries i and j .
Empirical Results
In this section we analyzed the feasibility of the formation of currency union based on
macroeconomic convergence and optimum currency area criteria. We first began with the
macroeconomic convergence. The average inflation rate is tabulated over the period 19802005 in ascending order 32(see Table 1). Though the average inflation rate for WAMZ zone
members is moderate compared to WAEMU region, countries such as Sierra Leone and
Ghana have recorded high average inflation rates. All WAMZ members’ average inflation
for the period 1980- 2005 exceeded the five percent inflation criterion. The inflation
variability is computed and we tabulated the result (see Table 2).
The following observation is in order: countries with highest average inflation rates top the
inflation variability table. In other words, countries with higher inflation rate also show
high inflation variability. Sierra Leone topped the inflation rate and inflation variability in
the WAMZ zone. In addition Sierra Leone also topped the inflation variability table for the
32
Countries with high inflation are on the top of the list while low inflation countries are found on
the bottom of the list.
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ECOWAS zone. WAMZ member countries maintained the same ordering position in terms
of inflation mean and variability. The results highlight the fact that inflation and inflation
variability co-move. When we compared the inflation rate and inflation variability for
WAMZ and WAEMU, WAEMU member countries showed relatively lower inflation rate
and inflation variability compared to the former (see tables 1 and 2). The implication is
that currency union could result in low average inflation rate and low inflation variability.
Considering the convergence criteria for WAMZ member countries, with the exception of
Ghana and Sierra Leone the rest of the zone members satisfied the criterion (inflation rate
less than or equal to 5 percent or inflation rate less than 1.5 percent of the average of the
three lowest rates within WAMZ) using average inflation 1980-2005. However, using 2005
average inflation rate, both Ghana and Sierra Leone meet the criterion. The implication is
that the national central banks are committed and are working hard in meeting the
convergence criteria.
We considered the second criterion where the interest rate of a country joining the currency
union must not exceed 2 percentage points of the interest rates observed in the three
countries with the lowest inflation rates. The average interest rate for the three lowest
countries is 13.1 percent.33 Again with the exception of Ghana, all WAMZ members
satisfied such criterion. Ghana’s average interest rate exceeds the 2 percentage points of the
average of the three countries. Interest rate movement from the period 1980-2002 is also
considered. A closer look at Ghana’s interest rate trend shows it declined in 2000 and
further declined by almost 50 percentage points from 2001 to 2002 (see Figure 1). 34 We also
looked at the exchange rate criterion.35 Gambia and Nigeria being the only exception, the
exchange rates for the rest of the zone fluctuate more than 3 percentage points vis-à-vis the
U.S. dollar (see figure 2). This is not in line with the European Union’s standard.
The fiscal policy criteria36 are examined using 2005 data. The results are presented in Table
3. Based on the findings, only Nigeria and Sierra Leone satisfied the debt/GDP criterion
with a debt to GDP ratio of 33.3 percent and 54.6 percent respectively37, while Gambia,
Guinea and Ghana have debt to GDP of 115, 84, and 73 percent respectively. In the deficit
33
To computer the average interest rate, we used average interest rates for Gambia, Guinea and
Nigeria using the period 1980-2002 and obtain : {(11.856+15.067+12.29)/3}=13.07
34 When 2005 inflation data is use, the average interest rate for the best three in terms of inflation
exceeds the interest rate for the worst two countries.
35 According European Union (1996) a currency will have to remain for at least two years within the
normal fluctuation margin on the assumption that the monetary union would continue to observe it
original 2.25 percent margin.
36 The fiscal policy criteria constituted budget deficit and public debt criteria.
37 Debt to GDP ratio should be at almost 60 percent.
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to GDP criteria, however, Ghana and Guinea met the requirement with deficit to GDP ratio
of 1.3 and 4.1 percent respectively. Looking at previous records, Gambia met the deficit to
GDP criterion from 2000-2003 averaging 3.5 percent but slipped off after 2004. Similarly,
Nigeria met the criterion from 2003-2004 but also slipped thereafter. The implication is
that as countries meet one criterion and are attempting to meet other criteria, the result is
often a trade-off and the subsequent missing of an already attained target. Based on the
macroeconomic convergence criteria results, it is safe to declare the WAMZ zone failed to
meet the macroeconomic convergence criteria.
Considering the optimum currency area criteria, we examined the three criteria which are
openness, diversification of individual economies, and labor mobility. We began with
openness which is measured as the ratio of the sum of exports and imports in goods and
services to GDP. Individual WAMZ countries’ members, average WAMZ and WAEMU
openness is presented in Table 4. The analysis revealed that WAMZ zone is determined to
be more open compared to WAEMU zone. Consequently, one can safely assert that WAMZ
zone meets the openness criterion of optimum currency criteria. The second criteria for
OCA- asymmetrical of shocks are also considered.
For the diversification of individual economies, the co-movements of macroeconomic
variables such as GDP, terms of trade, inflation, and current accounts are computed (see
Tables 5.1a - 5.4b). The co-movement results are mixed. On the one hand, there is greater
co-movement in macroeconomic variables such as GDP and inflation among WAMZ
countries than among WAEMU countries (see Tables 5.1a, 5.1b, 5.3a, and 5.3b). On the
other hand, there is more co-movement in macroeconomic variables such as terms of trade
and current account among WAEMU countries than among WAMZ countries (see Tables
5.2a, 5.2b, 5.4a, and 5.4b). The difference between average GDP co-movement among
WAMZ zone and WAEMU zone is relatively small, 0.053 and 0.058 respectively. 38 Similar
outcomes also arise from the difference between average terms of trade co-movement among
WAEMU and WAMZ countries averaging 0.150 and 0.202 respectively. However, the
difference between average inflation and current account balance co-movements between the
two zones is striking. Average inflation and current account co-movements among WAMZ
members are 0.887 and 1.15 respectively, while inflation and current account co-movement
among WAEMU is 1.005 and 0.73 respectively. Two caveats emerge from the analysis.
Firstly, the relatively small difference between the averages of GDP co-movements and terms
of trade of the two zones could be explained by GDP size and similar kind of shocks that
confront their economies. Secondly, the relative large difference between the average
inflation rate and current account balance co-movements can be explained as a result of the
existing currency union- WAEMU, which serves to impose fiscal discipline and stabilizes
38
Note the smaller the co-movement value the greater the co-movement
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inflation rate within the zone, which is contrary to WAMZ zone. Labor mobility criterion
is considered next.
Labor mobility within the zone is limited by language and cultural barriers. Though many
of the zone members have common official languages 39 that they inherited from their
colonial history, the zone comprises a cultural diversity that makes migrating and adapting
relatively difficult. In other words, the labor mobility within the zone does not provide
enough evidence to help smoothen the asymmetric terms of trade that confront the zone.
At this juncture, it is apparent that WAMZ zone does not constitute an OCA. The zone’s
failure to meet the convergence and OCA criteria need not prevent it from pursuing its
goal since entry into monetary union can lead to endogeneity40 of business cycle.
CONCLUSION AND POLICY IMPLICATIONS
In this paper the feasibility of WAMZ from macroeconomic convergence and optimum
currency areas criteria is examined. We first examine whether the zone meets the
macroeconomic convergence criteria. Data set includes annual data from 1980 to 2005. The
empirical analysis revealed that the zone does not meet the macroeconomic convergence
criteria. We then examine the optimum currency area criteria. Out of the three optimum
currency area criteria considered; openness, synchronization of shocks, and labor mobility,
the zone did well in openness criteria. However, labor mobility within the zone is relatively
low and shocks are not uniform. Consequently the zone failed to meet the OCA criteria as
well. The following policy prescriptions are drawn from the study:
First, member countries need to open up and encourage movement of people within the
region. Consequently, immigration laws need to be relaxed to some extent. A common
identification document (WAMZ Passport or WAMZ Identification card) need to be
introduced by WAMZ and acceptable to all members. This can ease the free movement of
people from one country to another within the region. WAMZ member countries also need
to diversify their economies so as to dampen the impact of an adverse economic shock
either internal or external.
Second, countries that are in a monetary union tend to maintain low inflation and
inflation variability. Average inflation in WAEMU zone remained low and at a single digit
compared to WAMZ zone where inflation averages a double digit. Consequently for
WAMZ member countries to achieve low inflation rate, they need to enter into a monetary
union.
39
Gambia, Ghana, Nigeria, and Sierra Leone speak English as their official , while Guinea speak
French
40 See Frankel and Rose
103
102
Third it can be observed that the degree of openness is greater in WAEMU compared to
WAMZ which is in line with the work of Frankel and Rose (1998). The average degree of
openness in WAEMU zone is 73 percent compared to 61 percent in WAMZ zone (see table
4). Moreover with the exception of The Gambia and Nigeria, the rest of WAMZ member
countries are below average. The implication is that currency union enhances openness and
openness increases trade and income (see Frankel and Rose (1998, 2002)). This implies that
for WAMZ member countries to reap the benefits of trade, they need to enter into a
monetary union.
Finally, the co-movement result shows that both WAMZ and WAEMU tend to have the
same average co-movement in Gross Domestic Product and terms of trade. The intuition is,
the two zones have similar economies and face similar economic shocks. However,
WAEMU tend to have greater co-movement in inflation compared to WAMZ zone. The
implication is, there is a single central bank in WAEMU zone that conducts monetary
policy. Belonging to a monetary union also enforces fiscal discipline and enforces inflation
control to a single digit. With the exception of inflation, there appear to be a greater comovement in WAMZ zone compared to WAEMU. The intuition is that WAMZ zone
economies tend to be more synchronized and entering into monetary union enhances the
zone’s tendency towards satisfying OCA criteria. The result is in line with the endogeneity
of the Optimum Currency Area (see Frankel and Rose (1998)).
Even though these countries are yet to enter in a monetary union, WAMZ member
countries have made some progress in meeting the required criteria. As a result, the
following observations need to be highlighted which may provide some insights to policy
makers, researchers, and politicians. Since 2007 all WAMZ member countries have shown a
single digit rate of inflation. As at 2009 inflation rate in the Gambia, Ghana, Guinea,
Nigeria and Sierra Leone stood at 3.0, 5.8, 3.5, 4.2, and 4.0 percent respectively. In addition
these figures show a downward trend since 2005 and with the exception of Ghana, all
member countries have met the inflation criterion. Similarly the fiscal criteria debt-to-GDP
show similar trend. All countries have shown a declined in their debt-to-GDP ratio. As at
2009 the debt-to-GDP ratio for Gambia, Ghana, Guinea, Nigeria, and Sierra Leone stood at
92.5, 50.6, 48.2, 28.7 and 60.6 percent respectively. Gambia being an exception, all member
countries met the debt-to-GDP criterion.
Taking a closer look at the average co-movement in prices, output, terms of trade, and
current account, the WAMZ zone performed as high as the WAEMU zone. The intuition is
that the zone faces similar kind of economic shocks. This reduces the cost of losing
independent monetary policy and facilitates monetary union formation. The implication is
that policy makers in member countries have shown some amount of commitment in the
formulation of a monetary union. Consequently, politicians need to be more involved so as
to demonstrate some degree of political will. The implication is that once there is a political
103
104
will, monetary union can kick-start without all members meeting all the required criteria 41.
Once there is political will among member-countries, the zone might benefit from the
union through the effects it has in enhancing trade and GDP per capita.
Table 1: Mean Annual Inflation in ECOWAS ZONE in percent 1980-2005
Countries ranked in descending order
Average
Sierra Leone
Guinea -Bissau
Ghana
Nigeria
Guinea
Liberia*
Gambia
Cape Verde
Cote d’Ivoire
Togo
Senegal
Benin
Niger
Burkina Faso
Mali
42.97
38.85
34.06
22.92
16.62
16.26
10.74
7.41
5.18
4.83
4.68
4.51
3.91
3.49
3.42
*Data for Liberia limited so I considered only 10 periods which are available
41 According to 1996 European Union report, only Germany, Luxemburg, and United Kingdom were
forecast to fulfill both deficit and debt criteria. Eight members show debt-to-GDP ratio rising.
104
105
Table 2: Inflation Rate Variability in percent within ECOWAS Zone 1980-2005
Countries with High Inflation variability
(Ranked by Standard Deviation of Inflation)
Standard
Deviation
Inflation
41.24
33.18
27.68
18.87
18.76
10.21
8.80
8.22
7.89
7.68
7.54
6.30
5.77
5.21
Sierra Leone
Guinea-Bissau
Ghana
Nigeria
Guinea
Gambia
Niger
Togo
Benin
Mali
Senegal
Cape Verde
Burkina Faso
Cote d’Ivoire
Table 3: Fiscal deficit criterion as of 2005 (Percent of GDP)
Country
Budget Deficit
(Limit = 5 percent)
Public Debt
(Limit = 60 percent)
Gambia
10.6
114.7
Ghana
1.3*
72.7
Guinea
4.1*
84.7
Nigeria
7.8
33.3*
Sierra Leone
9.3
54.6*
Source: WAMI and author’s calculations
Note: * denotes satisfactory
106
105
Table 4: Average openness in WAMZ zone (percent), 1980-2005
High Trade-Ratio Countries
Percentage
Gambia
Nigeria
Ghana
Guinea
Sierra Leone
WAMZ
WAEMU
108.30%
76.38%
55.60%
53.89%
46.35%
61.00%
73.10%
Table 5.1a: GDP Co-movement in WAMZ zone
Country
Gambia
Ghana
Guinea
Ghana
0.028
Guinea
0.031
0.023
Nigeria
0.030
0.038
0.036
Sierra Leone
0.095
0.084
0.077
Average real GDP co-movement in WAMZ zone is 0.053
106
107
Nigeria
0.092
Table 5.1b: GDP Co-movement WAEMU zone
Country
Benin
BurkinaCote
GuineaFaso
d’Ivoire
Bissau
Burkina0.026
Faso
Cote
0.038
0.047
d’Ivoire
Guinea0.093
0.097
0.092
Bissau
Mali
0.040
0.030
0.067
0.113
Mali
Niger
Niger
0.040
0.032
0.042
0.105
0.050
Senegal
0.023
0.027
0.037
0.093
0.046
0.035
Togo
0.060
0.057
0.053
0.091
0.073
0.052
Senegal
0.052
Average GDP Co-movement within WAEMU zone is 0.058
Table 5.2a: Terms of trade Co-movement in WAMZ
Country
Gambia
Ghana
Guinea
Ghana
0.172
Guinea
0.020
0.167
Nigeria
0.317
0.283
0.250
Sierra Leone
0.156
0.114
0.112
Average real Terms of trade co-movement in WAMZ is 0.202
107
108
Nigeria
0.248
Table 5.2b: Terms of trade Co-movement in WAEMU
Country
Benin
BurkinaCote
GuineaFaso
d’Ivoire
Bissau
Burkina0.138
Faso
Cote
0.199
0.143
d’Ivoire
Guinea0.213
0.181
0.199
Bissau
Mali
0.137
0.090
0.156
0.199
Mali
Niger
Niger
0.217
0.126
0.152
0.164
0.153
Senegal
0.166
0.109
0.128
0.146
0.110
0.124
Togo
0.138
0.131
0.146
0.179
0.105
0.145
Senega
l
0.112
Average terms of trade Co-movement within WAEMU is 0.150
Table 5.3a: Inflation Co-movement in WAMZ
Country
Gambia
Ghana
Guinea
Ghana
0.946
Guinea
0.718
0.813
Nigeria
1.149
0.792
0.823
Sierra Leone
0.816
1.003
0.801
Inflation Co-movement in WAMZ zone is 0.887
108
109
Nigeria
1.006
Table 5.3b: Inflation Co-movement in WAEMU zone
Country
Beni
Burkina Cote
Guinean
-Faso
d’Ivoire
Bissau
Burkina-Faso
0.358
Mali
Niger
Cote d’Ivoire
0.766
0.389
Guinea-Bissau
1.657
1.298
1.425
Mali
0.700
0.672
0.439
1.129
Niger
0.736
0.564
0.673
1.322
0.734
Senegal
0.972
1.250
0.673
1.387
1.634
1.646
Togo
0.883
0.888
1.110
1.818
0.934
1.044
Senegal
1.050
Average Inflation Co-movement within WAEMU zone is 1.005
Table 5.4a: Current Account Co-movement WAMZ zone
Country
Gambia
Ghana
Guinea
Ghana
1.26
Guinea
1.27
1.09
Nigeria
1.16
1.24
1.1
Sierra Leone
1.02
1.26
1.1
Average current account co-movement in WAMZ zone is 1.15
109
110
Nigeria
0.97
Table 5.4b: Current Account Co-movement in WAEMU zone
Country
Beni
BurkinaCote
GuineaMali
n
Faso
d’Ivoire
Bissau
Burkina-Faso 0.52
Cote d’Ivoire 0.72
0.92
Guinea0.95
1.03
0.85
Bissau
Mali
0.55
0.65
0.84
0.83
Niger
0.81
0.72
1.17
1.17
0.67
Senegal
0.47
0.69
0.53
0.7
0.47
Togo
0.44
0.57
0.77
0.93
0.42
Niger
0.88
0.66
Average current Account Co-movement within WAEMU zone is 0.73
Figure 1: Interest Rate in the WAMZ
Source: IFS (2006), WAMI (various Reports)
Figure 2: Exchange rate vis-à-vis US dollar and WAMZ member countries
Source: IFS (2006), WAMI (various Reports)
110
111
Seneg
al
0.51
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