Prospects for a Monetary Union in the East Africa Community: Some Empirical Evidence

• DOI: http://doi.org/10.1111/saje.12247
• Date: 01 June 2020
• Published date: 01 June 2020
• Author: Luis Gil‐Alana,Guglielmo Maria Caporale

South African Journal of Economics Vol. 88:2 June 2020

doi: 10.1111/saje.12247

174

PROSPECTS FOR A MONETARY UNION IN THE EAST

AFRICA COMMUNITY: SOME EMPIRICAL EVIDENCE

GUGLIELMO MARIA CAPORALE†,* AND LUIS GIL-ALANA‡

Abstract

This paper examines generalised purchasing power parity (G-PPP) and business cycle synchronisation

in the East Africa Community with the aim of assessing the prospects for a monetary union. The

univariate fractional integration analysis shows that the individual series exhibit unit roots and are

highly persistent. The fractional bivariate cointegration tests suggest that there exist bivariate fractional

cointegrating relationships between the exchange rate of the Tanzanian shilling and those of the other

EAC countries, and also between the exchange rates of the Rwandan franc, the Burundian franc and

the Ugandan shilling. The Fractionally Cointegrated Vector AutoRegressive (FCVAR) results imply

the existence of a single cointegrating relationship between the exchange rates of the EAC countries.

On the whole, there is evidence in favour of G-PPP. In addition, there appears to be a high degree

of business cycle synchronisation between these economies. On both grounds, one can argue that a

monetary union should be feasible.

JEL Classification: C22, C32, F33

Keywords: East Africa Community, monetary union, optimal currency areas, fractional integration

and cointegration, business cycle synchronisation, Hodrick–Prescott filter

1. INTRODUCTION

This paper aims to assess the prospects for a monetary union in the East African

Community (EAC), a group of six countries intending to achieve a common monetary

policy and currency by 2024, by considering some of the conditions for an optimal cur-

rency area (OCA). More specifically, it applies fractional cointegration methods to test

whether generalised purchasing power parity (G-PPP) holds in the EAC. In addition, it

examines business cycle synchronisation by using the Hodrick–Prescott (HP) filter to de-

compose GDP into trend and cyclical components and measure the degree of correlation

between the latter in this set of countries. Because South Sudan joined the EAC only in

April 2016, and therefore, very few observations are available for this country, the analysis

focuses on the other five members of the union only.

Unlike earlier studies on the EAC based on the classical I(0)/I(1) dichotomy (see, e.g.

Buigut and Valev, 2005; Buigut, 2011; Mafusire and Brixiova, 2013; Yabara, 2014), we

adopt a fractional cointegration framework that allows for long memory in the residuals

* Corresponding author: Department of Economics and Finance, Brunel University London,

Uxbridge, Middlesex UB8 3PH, UK. E-mail: Guglielmo-Maria.Caporale@brunel.ac.uk

† Department of Economics and Finance, Brunel University London

‡ University of Navarra, Pamplona, Spain

© 2020 The Authors. South African Journal of Economics published by John Wiley & Sons Ltd on behalf of Economic

Society of South Africa

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

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