Macroeconomic Convergence in the East African Community: A Multivariate Cointegration Analysis of the Exchange Rates

Abstract

The EAC member countries have to-date implemented various reforms with the aim of achieving macroeconomic convergence before the on-coming EAST African Monetary Union, however, the extent of convergence to-date is an empirical question that is yet to be answered.  Various researchers have used the Johansen approach to investigate cointegration but have not catered for the gradual changes that occur during the adjustment period.  This study revisited the definition of convergence based on Johansen cointegration approaches to include zero mean, conditional deterministic, stochastic, conditional and unconditional stochastic convergence; and unlike other studies, applied a rolling multivariate cointegration/convergence approach to investigate the extent to which exchange rates in the East African Community (EAC) have converged following macroeconomic reforms.   Rolling Johansen, rolling multivariate Engle and Granger, impulse response and Granger-causality approaches were applied.  The results revealed that existence of cointegration does not necessarily mean complete convergence. Although the exchange rates in the EAC were cointegrated, there was limited convergence and uni-directional causality in most cases.  The shocks arising from Kenya had major effects on the exchange rates for other countries in the region; those from Rwanda affected that for Burundi while shocks arising elsewhere had minimal effects.  To ensure smooth transitions in the monetary union, reforms that can ensure convergence thus stable exchange rates are required.

Keywords: Macro-economic convergence, Multivariate rolling cointegration tests, Exchange rates, Granger-causality,   East African Community integration

JEL Nos. C32, E52, E61, E63, F15