Motivation of this paper Answer the following questions:

1. Motivation of this paper Answer the following questions: 1) Has the Common Monetary Area (henceforth CMA) in Southern Africa ever been an optimal currency area, especially after its re-foundation in 1986-1992? 2) What are the costs and benefits of CMA for its member countries? How can we test their impact on the operation of the monetary area? “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits?Martin Grandes, DELTA and OECD Development Centre

2. This presentation CMA history. Major events and main features A two-step econometric exercise to test for OCA criteria 2-1. RER Co-Movements and G-PPP 2-2. Accounting for OCA’s costs and benefits in a panel G-PPP approach. 3) Concluding remarks. Future prospects for CMA. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits?

3. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 1)-Brief Reminder of CMA history. Major events, main features Important: pegs are not irrevocable

4. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 1)-Brief Reminder of CMA history. Major events, main features Low bilateral trade intensities. Import dependence from SA

5. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? • A two-step econometric exercise to test for OCA criteria • 2-1) Real Exchange Rates Comovements and the theory of Generalised PPP. • Open economies, high tradable production share, low transaction costs - short distances. PPP doesn’t seem unreasonable. • Idea: although bilateral RER are generally non-stationary, G-PPP hypothesises that they will exhibit common stochastic trends if the fundamental variables (i.e. the forcing variables) are sufficiently interrelated. This may happen in a currency domain (Enders and Hurns, 1994). See chart 1. • Within a currency area we would expect there to be at least one linear combination of the various bilateral real exchange rates that is stationary. We test for cointegration among different RER

6. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-1) Real Exchange Rates Comovements and the theory of Generalised PPP.

7. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-2) Real Exchange Rates Comovements and the theory of Generalised PPP.

8. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-1) Real Exchange Rates Comovements and the theory of Generalised PPP. The results confirm the cointegration between the different RERs Use Johansen’s methodology Check variables stationarity: all are I(1) Choose optimal lag number (VAR Sims’ test) => perform the Johansen test under the assumption of no deterministic trend in data (reasonable for our data generation process) Finally, we obtain the number of cointegrating vectors (2), confirming G-PPP holds. =>Our finding shows that the RERs in CMA countries and Botswana vary quite similarly, indicating that the underlying economic shocks or policy responses to them do not spark divergent relative price effects. .

9. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? • 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach • Deviations from PPP can be a signal of different macro-fundamental responses driving divergent needs to smooth external shocks out, i.e. by the use of the exchange rate instrument. • Enders’ test offers a proof of such divergence but does not necessarily provides an explanation of which factors might be driving different adjustments in relative prices. • Conversely, the criteria suggested by OCA’s theorists lays out a useful framework to pin down the factors that can be bearing upon the degree of compliance with G-PPP. • Idea: given the fixed exchange rate arrangements in place (or quasifixed in Botswana), any diverging/converging fluctuations in CPIs should be accounted for by OCA’s theoretical variables in either sense .

10. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? • 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach • We propose a “new” exercise, starting from Bayoumi and Eichengreen (1996 and 1998), though different dependent variable, and control for capital flows composition and product diversification: • Dependent variable: country-pair correlations in CPIs; lower than one or negative=> different need of RER adjustment. • Explanatory variable set: OCA’s cost/benefit variables, namely: • The degree of total trade openness • Diversification of production and exports of goods and services • Shock asymmetry (or business cycle synchronisation) • Capital mobility and composition of gross capital inflows • Trade off between openness and diversification (interactive variable)

11. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach The degree of total trade openness (OPEN ij)(+)

12. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach Diversification of production and expts of goods and services (HERFIN ij)(-)

13. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach Shock Asymmetry (LOGOUTPUT ij)(-)

14. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach Capital mobility and composition of gross capital inflows (FDIGKI)(-) No reliable data on capital mobility. Free and unidirectional in practice.

15. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach `=>Estimate the following equation:

16. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits? 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach

17. 2-2) Accounting for OCA’s cost/benefits in a panel G-PPP approach Conclusions: Advantages and disadvantages of being in CMA (measured as a function of relative price correlations). On the one hand, the more open and more similarly diversified the economies are, the higher the benefits they will reap from having joined. On the other hand, the less synchronised their business cycles come about, and the more different the kind of capital inflows are, the higher the costs they will have to bear provided internal capital mobility is low. Finally there is also a positive joint effect from a higher degree of openness and similarly higher degrees of diversification. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits?

18. Lessons from this paper Positive balance. Econometric evidence in favour of the existence of an OCA in CMA plus Botswana. A way towards a fully-fledged monetary union? PROS High degree of trade openness and tradability of CPI. Higher real output correlation. Risk-hedging possibility since periphery countries are able to resort to South Africa’s capital market. Perfect match to CA deficits. CONS: Divergent terms of trade shocks; low export diversification. Dissimilar capital inflows, low internal capital mobility. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits?

19. Future Work No ground for endogeneity criteria? Here, the existence of a monetary union didn’t seem to have boosted trade (see Rose 2002). One-way direction of trade intra CMA. Further work on Rose-Krugman dilemma. Increased cycle synchronicity would not result from augmenting trade… …Provided the predominant inter-industrial trade pattern and low bilateral trade intensities. Recent Rand volatility as well as trade composition and different terms of trade shocks support the case for a currency basket or a new currency linked to trade weighs. “Southern Africa’s Monetary Area: an OCA? Which Costs? Which Benefits?