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Concept and Theory of Macroeconomic Policy Convergence and Monetary Union Noah Mutoti UNECA Workshop July 26-27, Addis Ababa. Outline. Why Macroeconomic Policy Convergence? Nominal Versus Real Convergence Link between Convergence and OCA Benefits and Costs of Monetary Union

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  1. Concept and Theory of Macroeconomic Policy Convergence and Monetary UnionNoah MutotiUNECA WorkshopJuly 26-27, Addis Ababa

  2. Outline • Why Macroeconomic Policy Convergence? • Nominal Versus Real Convergence • Link between Convergence and OCA • Benefits and Costs of Monetary Union • Convergence Measurement • Measuring the OCA Criteria • Methodology of the paper

  3. Why is macroeconomic policy convergence a desirable outcome for RECs? • Smaller poorer countries of the convergence club should catch up with richer ones • Openness to trade fosters catch-up convergence • Commitments towards anti-inflationary policies and fiscal stability • Foster monetary-fiscal policy co-ordination • Given that the ultimate objective of regional integration is the adoption of a single currency, the concept of policy convergence is related to OCA theory

  4. Nominal Versus Real Convergence • Nominal convergence is related to the convergence of variables such as inflation rate, budget deficit and public debt . • Real convergence comprehends to the convergence in per capita incomes and productivity, convergence in labour markets, homogenization of economic structures. • What are the links between nominal and real convergence? • Nominal convergence leads to real convergence . • This is because macroeconomic stability (price stability and fiscal discipline), the removal of the exchange-rate risk, the reduction of uncertainty concerning inflation will ultimately leads to stronger growth.

  5. What is the link between Policy Convergence and OCA Theory? • OCA theory is principally a discussion of the monetary union • Monetary integration implies that national monetary policies need to converge • Convergence of macroeconomic policies does not only assist in the gradual elimination of policy shocks, but it also has the potential to cause similarity of shocks, thereby reducing the costs of monetary unification.

  6. What are Benefits and Costs of a Monetary Union? • According to the OCA theory, a country should join a monetary union if the savings it will realize in transaction costs are greater than the costs induced by foregoing national exchange rate and monetary policy. • Adjustment costs depend on the symmetry of the shocks an economy is facing • If all the members of a monetary union face the symmetric shocks, there is no cost in having a common policy. • When faced with asymmetric shocks, countries will suffer higher adjustment costs

  7. Benefits of a Monetary Union • Macroeconomic stability • There is central bank commitment to reducing inflation • Increase in trade • Creates larger market • Reduces transaction costs between trading partners • Savings on external reserves • No need for reserves for intra-regional transactions • Political advantage.

  8. Costs of Monetary Union • Loss of autonomy of monetary policy • No autonomous monetary policy, thus losing a degree of freedom in reacting to external shocks. • Loss of autonomy in fiscal policy. • This is premised on the fact that in the absence of fiscal discipline a monetary union may break down.

  9. Convergence Measurement • Simple measure of dispersion of the variables (i.e., standard deviation) called sigma convergence • Beta convergence • Unit roots test • Cointegration.

  10. Measuring the OCA Criteria • While the econometric methodologies to assess OCA criteria vary, they focus on determining the size and magnitude of asymmetries in supply and demand shocks. • Decomposition of the series into trends and cycles, leading to the measurement of business cycle similarities or differences across countries • The VAR model, which decomposes the shocks into supply and demand components. • Cross country regressions are used to distinguish country specific shocks.

  11. Measuring the OCA Criteria • The importance of a shock depends on two factors • Size and magnitude of its impact on macroeconomic aggregates • The correlation of these shocks across countries. • Positive correlation characterize symmetry). • Negative correlation characterize asymmetry • The lower or less significant the coefficient, the less the importance of the issue of (a)symmetry.

  12. Methodology of this paper • Heterogeneous panel unit root tests to examine macroeconomic convergence in SADC, COMESA, EAC and ECOWAS. • Cointegrated VAR framework to test the OCA theory.

  13. Thank you

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