Monetary unions among developing and emerging markets: how many currencies does africa need?
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Transcript of Monetary unions among developing and emerging markets: how many currencies does africa need?
Despite Africa’s great diversity of culture and languages, many Africans identify themselves as Africans first, then as Congolese, Kenyans, Nigerians, South Africans, etc.Most Europeans, North Americans, and Asians
have it the other way round: country first, then continent
Yet, national boundaries within Africa are generally less open than those within EuropeVarious restrictions on trade and migrationRestrictions need to be relaxed to spur growth National currencies constitute a trade restrictionNational currencies constitute a trade restriction
In view of the success of the EU and the euro, economic and monetary unions appeal to many Africans and others with increasing force
Consider four categoriesExisting monetary unionsDe facto monetary unionsPlanned monetary unions Previous – failed! – monetary unions
CFA franc14 African countries
CFP franc3 Pacific island states
East Caribbean dollar8 Caribbean island states
Picture of Sir W. Arthur Lewis, the great Nobel-prize winning development economist, adorns the $100 note
Euro, more recent16 EU countries plus 6 or 7 others
Thus far, clearly, a major success in view of old conflicts among European nation states, cultural variety, many different languages, etc.
Australian dollar Australia plus 3 Pacific island states
Indian rupee India plus Bhutan (plus Nepal)
New Zealand dollar New Zealand plus 4 Pacific island states
South African rand South Africa plus Lesotho, Namibia, Swaziland –
and now Zimbabwe Swiss franc
Switzerland plus Liechtenstein US dollar
US plus Ecuador, El Salvador, Panama, and 6 others
East African shilling (2009) Burundi, Kenya, Rwanda, Tanzania, and
Uganda Eco (2009)
Gambia, Ghana, Guinea, Nigeria, and Sierra Leone (plus, perhaps, Liberia)
Khaleeji (2010) Bahrain, Kuwait, Qatar, Saudi-Arabia, and
United Arab Emirates Other, more distant plans
Caribbean, Southern Africa, South Asia, South America, Eastern and Southern Africa, Africa
Danish krone 1885-1938 Denmark and Iceland 1885-1938: 1 IKR = 1 DKR 2009: 2,300 IKR = 1 DKR (due to inflation in
Iceland) Scandinavian monetary union 1873-1914
Denmark, Norway, and Sweden East African shilling 1921-69
Kenya, Tanzania, Uganda, and 3 others Mauritius rupee
Mauritius and Seychelles 1870-1914 Southern African rand
South Africa and Botswana 1966-76 Many others
No significant
divergence of
prices or currency
rates following
separation
CentripetalCentripetal tendency to joinjoin monetary unions, thus reducing number of currencies To benefit from stable exchange rates stable exchange rates at the
expense of monetary independence CentrifugalCentrifugal tendency to leaveleave monetary
unions, thus increasing number of currenciesTo benefit from monetary independence monetary independence often,
but not always, at the expense of exchange rate stability
With globalization, centripetal tendencies appear stronger than centrifugal onesWhat does this mean for Africa?
FREE CAPITAL MOVEMENTS
FIXEDEXCHANGE
RATE
MONETARYINDEPENDENCE
MonetaryMonetaryUnion (EU)Union (EU)
Flexible Flexible exchange exchange rate (US, UK, Japan)rate (US, UK, Japan)
Capital controls Capital controls (China)(China)
Free to choose
only two of three
options; must
sacrifice one
If capital controls are ruled out in view of the proven benefits of free trade free trade in goods, services, labor, and also capital (four freedomsfour freedoms), …
… then long-run choice boils down to one between monetary independencemonetary independence (i.e., flexible exchange rates) vs. fixed ratesflexible exchange rates) vs. fixed rates Cannot have both!Cannot have both!
Either type of regime has advantages as well as disadvantages
Let’s quickly review main benefits and costs
BenefitsBenefits CostsCosts
Fixed Fixed exchange exchange ratesrates
Floating Floating exchange exchange ratesrates
BenefitsBenefits CostsCosts
Fixed Fixed exchange exchange ratesrates
Stability of Stability of trade and trade and investmentinvestment
Low inflationLow inflation
Floating Floating exchange exchange ratesrates
BenefitsBenefits CostsCosts
Fixed Fixed exchange exchange ratesrates
Stability of Stability of trade and trade and investmentinvestment
Low inflationLow inflation
InefficiencyInefficiency
BOP deficitsBOP deficits
Sacrifice of Sacrifice of monetary monetary independenceindependence
Floating Floating exchange exchange ratesrates
BenefitsBenefits CostsCosts
Fixed Fixed exchange exchange ratesrates
Stability of Stability of trade and trade and investmentinvestment
Low inflationLow inflation
InefficiencyInefficiency
BOP deficitsBOP deficits
Sacrifice of Sacrifice of monetary monetary independenceindependence
Floating Floating exchange exchange ratesrates
EfficiencyEfficiency
BOP BOP equilibriumequilibrium
BenefitsBenefits CostsCosts
Fixed Fixed exchange exchange ratesrates
Stability of Stability of trade and trade and investmentinvestment
Low inflationLow inflation
InefficiencyInefficiency
BOP deficitsBOP deficits
Sacrifice of Sacrifice of monetary monetary independenceindependence
Floating Floating exchange exchange ratesrates
EfficiencyEfficiency
BOP BOP equilibriumequilibrium
Instability of Instability of trade and trade and investmentinvestment
InflationInflation
In view of benefits and costs, no single exchange rate regime is right for all countries at all times
The regime of choice depends on time and circumstance If inefficiencyinefficiency and slow growth due to
currency overvaluation are the main problem, floating rates can help
If high inflationinflation is the main problem, fixed exchange rates can help, at the risk of renewed overvaluation
Ones both problems are under control, time may be ripe for monetary union
The real exchange rate always floats Through nominal exchange rate adjustment
or price changes Even so, it does make a difference how
countries set their nominal exchange rates because floating takes time
Currency misalignments can persist Hence, a wide spectrum of options,
from absolutely fixed rates anchored through monetary unions to completely flexible exchange rates
What do countries do?
No national currency 17%Other types of fixed rates 23Dollarization 5Currency board 4Crawling pegs 3Bilateral fixed rates 3Managed floating 26Pure floating 19 100
51%
49%
Gradual tendency towards floatingtendency towards floating, from 10% of LDCs in 1975 to over 50% today, followed by increased interest in fixed ratesincreased interest in fixed rates through economic and monetary unions
Governments sometimes prefer fixed exchange rates so they can try to keep their national currencies overvalued To keep foreign exchange cheap To retain power to ration scarce foreign
exchange To make GNP in dollars look larger than it is
Another reason for persistent overvaluation, and thereby also sluggish trade and slow growth Inflation! Show by simple numerical example
Time
Real exchange rate
100
110105
Average
Suppose inflation is 10 percent per year and exchange rate adjusts with a lag
Time
100
120
Real exchange rate
110 Average
So, increased
inflation
increases real
exchange rate
as long as as long as
nominal nominal
exchange rate exchange rate
adjusts with a adjusts with a
laglag
Suppose inflation rises to 20 percent per year
Many African countries’ history of inflation, overvaluation, and slow growth is stark reminder that one of the keys to successful entry into monetary union is making sure that initial exchange rate at point of entry is not too highnot too high
European countries on euro zone’s doorstep – Baltic countries, Sweden, Iceland – face same challenge
Thank youThese slides can be viewed on my
website:
www.hi.is/~gylfason