Exchange Rate Convergence in the East African Monetary Union: An Econometric Investigation

Abstract

The paper initially revisits the definition of convergence in bivariate sense to cater for gradual changes which occur from one point to another and distinguishes between the different levels of convergence including zero mean, conditional deterministic, stochastic, conditional and unconditional stochastic convergence, and re-categories the conditional stochastic convergence and conditional deterministic as being either static or dynamic depending on whether the constant in the convergence equation increases, remains constant or decreases as the convergence progresses, with dynamic convergence occurring when the constant decreases overtime.  This is an expansion of the approach of previous  studies that mainly focused on  three general types of convergence of stochastic, deterministic and zero mean convergence, described by Halket (2005), mainly based on the entire sample being investigated without capturing the gradual changes that occur from one period to another using a rolling approach. This approach captureS the dynamic nature of the stochastic changes which occur before, during, and after the convergence is attained.  After revisiting the above, the study investigated the extent of convergence of the exchange rates for the East African Community using the rolling bivariate cointegration approach, accounting for structural breaks using the Sup LM test.  The motivation was that the EAC member countries for several years have been implementing reforms aimed at attaining macroeconomic convergence as a measure to ensure a successful Monetary Union. Whether it has been attained is an empirical question.  The results revealed limited convergence of the exchange rates, which has serious negative implications for the success of the EA Monetary Union.   This calls for review of the current monetary policies, and macroeconomic policies in general.

Keywords: Convergence, Rolling Bivariate Cointegration, Structural Break LM Test,  Exchange Rates,   EAC- Integration

JEL Nos. F15, E152, C12, C13, C32