Transcript Monetary unions among developing and emerging markets

Thorvaldur Gylfason
 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 Europe



Various restrictions on trade and migration
Restrictions need to be relaxed to spur growth
National 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 categories
 Existing
monetary unions
 De facto monetary unions
 Planned monetary unions
 Previous – failed! – monetary unions
 CFA

franc
14 African countries
 CFP

3 Pacific island states
 East

franc
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.

Australian dollar


Indian rupee


South Africa plus Lesotho, Namibia, Swaziland – and
now Zimbabwe
Swiss franc


New Zealand plus 4 Pacific island states
South African rand


India plus Bhutan (plus Nepal)
New Zealand dollar


Australia plus 3 Pacific island states
Switzerland plus Liechtenstein
US dollar

US plus Ecuador, El Salvador, Panama, and 6 others
 East

Burundi, Kenya, Rwanda, Tanzania, and Uganda
 Eco

African shilling (2009)
(2009)
Gambia, Ghana, Guinea, Nigeria, and Sierra
Leone (plus, perhaps, Liberia)
 Khaleeji

Bahrain, Kuwait, Qatar, Saudi-Arabia, and United
Arab Emirates
 Other,

(2010)
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


East African shilling 1921-69


Mauritius and Seychelles 1870-1914
Southern African rand


Kenya, Tanzania, Uganda, and 3 others
Mauritius rupee


Denmark, Norway, and Sweden
South Africa and Botswana 1966-76
Many others
 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?
FREE CAPITAL
MOVEMENTS
Monetary
Union (EU)
FIXED
EXCHANGE
RATE
MONETARY
INDEPENDENCE
FREE CAPITAL
MOVEMENTS
FIXED
EXCHANGE
RATE
Capital controls
(China)
MONETARY
INDEPENDENCE
FREE CAPITAL
MOVEMENTS
Flexible
exchange
rate (US, UK, Japan)
FIXED
EXCHANGE
RATE
MONETARY
INDEPENDENCE
FREE CAPITAL
MOVEMENTS
Flexible
exchange
rate (US, UK, Japan)
Monetary
Union (EU)
FIXED
EXCHANGE
RATE
Capital controls
(China)
MONETARY
INDEPENDENCE
 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
 Let’s quickly review main benefits and costs
Benefits
Fixed
exchange
rates
Floating
exchange
rates
Costs
Benefits
Fixed
exchange
rates
Floating
exchange
rates
Stability of trade
and investment
Low inflation
Costs
Benefits
Fixed
exchange
rates
Floating
exchange
rates
Costs
Stability of trade Inefficiency
and investment BOP deficits
Low inflation
Sacrifice of
monetary
independence
Benefits
Costs
Fixed
exchange
rates
Stability of trade Inefficiency
and investment BOP deficits
Low inflation
Sacrifice of
monetary
independence
Floating
exchange
rates
Efficiency
BOP equilibrium
Benefits
Costs
Fixed
exchange
rates
Stability of trade Inefficiency
and investment BOP deficits
Low inflation
Sacrifice of
monetary
independence
Floating
exchange
rates
Efficiency
BOP equilibrium
Instability of
trade and
investment
Inflation
 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
 The



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


real exchange rate always floats
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
Other types of fixed rates
Dollarization
Currency board
Crawling pegs
Bilateral fixed rates
Managed floating
Pure floating
17%
23
5
4
3
3
26
19
100
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
49%
51%
 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
Real exchange rate
Suppose inflation is
10 percent per year
and exchange rate
adjusts with a lag
110
105
100
Average = 105
Time
Real exchange rate
Suppose inflation rises
to 20 percent per year
120
110
Average = 110
100
Time
 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 zone’s doorstep –
Baltic countries, Sweden, Iceland – face same
challenge