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

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, C3

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

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, F1