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Monetary unions among developing and emerging markets: how many currencies does africa need?

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Despite Africa's great diversity of culture and languages, many Africans ... then long-run choice boils down to one between monetary independence (i.e. ... – PowerPoint PPT presentation

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Title: Monetary unions among developing and emerging markets: how many currencies does africa need?


1
Monetary unions among developing and emerging
markets how many currencies does africa need?
50TH ANNIVERSARY CELEBRATION OF THE CENTRAL BANK
OF NIGERIA, 4-6 MAY 2009
  • Thorvaldur Gylfason

2
Pan-continental africa
  • Despite Africas 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 Europe
  • Various restrictions on trade and migration
  • Restrictions need to be relaxed to spur growth
  • National currencies constitute a trade restriction

3
This is why we have Fewer currencies than
countries
  • 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 categories
  • Existing monetary unions
  • De facto monetary unions
  • Planned monetary unions
  • Previous failed! monetary unions

4
Existing monetary unions
  • CFA franc
  • 14 African countries
  • CFP franc
  • 3 Pacific island states
  • East Caribbean dollar
  • 8 Caribbean island states
  • Picture of Sir W. Arthur Lewis, the great
    Nobel-prize winning development economist, adorns
    the 100 note
  • Euro, more recent
  • 16 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.

5
De facto monetary unions
  • 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

6
Planned monetary unions
  • 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

7
Previous monetary unions
  • 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
8
Conflicting forces
  • Centripetal tendency to join monetary unions,
    thus reducing number of currencies
  • To benefit from stable exchange rates at the
    expense of monetary independence
  • Centrifugal tendency to leave monetary unions,
    thus increasing number of currencies
  • To benefit from monetary independence often, but
    not always, at the expense of exchange rate
    stability
  • With globalization, centripetal tendencies appear
    stronger than centrifugal ones
  • What does this mean for Africa?

9
Impossible trinity
Free to choose only two of three options must
sacrifice one
FREE CAPITAL MOVEMENTS
2
Monetary Union (EU)
1
3
FIXED EXCHANGE RATE
MONETARY INDEPENDENCE
10
Impossible trinity
Free to choose only two of three options must
sacrifice one
FREE CAPITAL MOVEMENTS
2
1
3
FIXED EXCHANGE RATE
MONETARY INDEPENDENCE
Capital controls (China)
11
Impossible trinity
Free to choose only two of three options must
sacrifice one
FREE CAPITAL MOVEMENTS
2
Flexible exchange rate (US, UK, Japan)
1
3
FIXED EXCHANGE RATE
MONETARY INDEPENDENCE
12
Impossible trinity
Free to choose only two of three options must
sacrifice one
FREE CAPITAL MOVEMENTS
2
Flexible exchange rate (US, UK, Japan)
Monetary Union (EU)
1
3
FIXED EXCHANGE RATE
MONETARY INDEPENDENCE
Capital controls (China)
13
Fix or flex?
  • If capital controls are ruled out in view of the
    proven benefits of free trade in goods, services,
    labor, and also capital (four freedoms),
  • then long-run choice boils down to one between
    monetary independence (i.e., flexible exchange
    rates) vs. fixed rates
  • Cannot have both!
  • Either type of regime has advantages as well as
    disadvantages
  • Lets quickly review main benefits and costs

14
Benefits and costs
Benefits Costs
Fixed exchange rates
Floating exchange rates
15
Benefits and costs
Benefits Costs
Fixed exchange rates Stability of trade and investment Low inflation
Floating exchange rates
16
Benefits and costs
Benefits Costs
Fixed exchange rates Stability of trade and investment Low inflation Inefficiency BOP deficits Sacrifice of monetary independence
Floating exchange rates
17
Benefits and costs
Benefits Costs
Fixed exchange rates Stability of trade and investment Low inflation Inefficiency BOP deficits Sacrifice of monetary independence
Floating exchange rates Efficiency BOP equilibrium
18
Benefits and costs
Benefits Costs
Fixed exchange rates Stability of trade and investment Low inflation Inefficiency BOP deficits Sacrifice of monetary independence
Floating exchange rates Efficiency BOP equilibrium Instability of trade and investment Inflation
19
Benefits and costs
  • 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 inefficiency and slow growth due to currency
    overvaluation are the main problem, floating
    rates can help
  • If high inflation 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

20
Benefits and costs
  • 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?

21
What countries actually do (2004, 193 countries)
No national currency 17 Other types of fixed
rates 23 Dollarization 5 Currency
board 4 Crawling pegs 3 Bilateral fixed
rates 3 Managed floating 26 Pure
floating 19
100
49
51
Gradual tendency towards floating, from 10 of
LDCs in 1975 to over 50 today, followed by
increased interest in fixed rates through
economic and monetary unions
22
overvaluation through inflation
  • 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

23
overvaluation through inflation
Real exchange rate
Suppose inflation is 10 percent per year and
exchange rate adjusts with a lag
110
Average 105
105
100
Time
24
overvaluation through inflation
So, increased inflation increases real exchange
rate as long as nominal exchange rate adjusts
with a lag
Real exchange rate
Suppose inflation rises to 20 percent per year
120
110
Average 110
100
Time
25
overvaluation through inflation
  • 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 high
  • European countries on euro zones doorstep
    Baltic countries, Sweden, Iceland face same
    challenge

These slides can be viewed on my website
www.hi.is/gylfason
Thank you
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