Is the East African Community an Optimum Currency Area?

Abstract

This paper investigates whether the East African Community (EAC) constitutes an optimum currency area (OCA) by estimating the degree and evolution of business cycle synchronization between the EAC countries. We also investigate whether the degree of business cycle synchronization has improved after signing of the EAC treaty in 1999. The degree of business cycle synchronization is estimated using an unobserved components model of structural shocks obtained from a structural VAR model. We then use a time-varying parameter model to estimate the evolution of business cycle synchronization. Our results indicate that the proportion of shocks that is common across different countries is small, implying weak synchronization. However, we also find that the degree of synchronization has improved after signing of the EAC treaty in 1999.East African Community, Optimum Currency Area, Business Cycle Synchronization, Structural VAR, State-Space Model