Thierry KAME BABILLAUniversity of Yaoundé II

African Economic Conference (AEC)Regional Integration in Africa

28-30 October, 2013

Outline

Motivation

Contribution

Litterature

Methodology

Main results

Conclusion and Policy implications

Motivation(1/2)

Motivation (2/2)

In this paperExamine the effects of currency unions to

the intensification of regional integration in CFA Zone.

Focussing in two structural breaks, namely, trade and risk sharing according to CFA Zone features.

Apply in CFA Zone a methodology that is largely recommended for the analysis of structural break whithin currency unions for regional integration.

Related litteratureThis research complements recent papers on Currency Unions for

Regional Integration, via trade or risk sharing.

1. Beyond Tsangarides & Van den Boogaerde (2005), Charalambos et al. (2006), Masson (2008), Batté et al. (2009), Tapsoba (2009), Debrun et al. (2010) ;

We assess the effect of currency unions on regional integration analysis in Africa using a two-country DSGE model.

2. Beyond Lama and Rabanal (2012); We features trade and risk sharing to analyse regional integration

whithin a currency in Africa.

3. Beyond Punnoose and Peersman (2012); We introduce risk sharing structural break with specific

application to CFA zone.

3.Beyond Badarau et Levieuge (2011 ); We incorporated trade structural break with specific application in

CFA Zone.

DSGE Model features Common Currency Areas;

Two Economy sharing common currency;

Bilateral Trade between CEMAC and WAEMU ;

risk sharing between CEMAC and WAEMU;

Bank credit market imperfection;

Financial asymmetries;

Economic agent behavior is analyzed separately for each economy of the currency union;

The model considered seven categories of national agents in each economy, namely households, entrepreneurs, retailers, capital producers, banks, Central Bank and Government.

HouseholdsEach Household maximise a lifetime utility funtion to

choose consumption basket and supply labor.

Because the model consists of a two-country currency union, consumption is a composite index which depends on the consumption of goods produced in CEMAC and goods produced in the WAEMU, as follow:

1 1

0

max1 1

C h

C hk C t h t

tk C h

C HE

11 2

1

1* *1 2*

1

11

21

C CCountry C

C CCountry C

ProductionProducers of wholesale goods Producers in each economy of the currency union, combine labor

and capital as input to produce wholesale goods . Labor input is a composite index of households labor and

entrepreneurial labor to ensure consistency of the credit market modeling.

Capital producers Capital adjustment costs is introduced Capital producers buy units of final goods and transform them in

physical capital sold to the entrepreneurs

Retailers Retailers are represented by firms, held by households, which purchase

wholesale goods and retail them afterwards. Their main role is to differentiate final goods. This behavior of retailers

justifies the introduction of price inertia in the model.

Banks and Financial intermediationFinancial relation between banks and firms:To produce final goods, the firm acquires, in each

period t, a quantity of physical capital.Firms finance their investment project by borrowing

from a bank .Banks collects funds to household to provide loan to

firms, as given:

Financial relation between banks and householdsBanks collect a portion of the household savings.Households pay an audit cost to have information about

thier agent (Bank).The optimization program that defines the terms of the

financial contract between the household and bank leads to the bank external financing premium :

1t t t t tA Q K NF NB

1 1

1 1 1 1 1

1 Bt t t t

A B ft t t t t t t t t t

MaxE R B

E G R B R Q K NF NB

Central Bank and GovernmentCentral Bank Program The common Central Bank conducts a unique monetary

policy following a standard monetary policy rule:

Government Program Governments intervene in the economy by an active policy of

public spending, funded by lump sum taxes , expressed in the following general form of national fiscal rule:

0 1 0 1 2ˆ ˆ ˆ ˆ1n n UM UMt t t t rr r y

1

* * * *1

ˆ ˆ 1

ˆ ˆ 2

t

t

t g t g

t g t g

g g in country

g g in country

Result 1: Impulse Response Function of Monetary Policy Shock. CEMAC(blue) vs. WAEMU(green)

Result 2: Impulse Response Function of Productivity Shock. CEMAC(blue) vs. WAEMU(green)

Result 3: Impulse Response Function of fiscal Shock. CEMAC(blue) vs. WAEMU(green)

ConclusionCurrency union didn’t contribute to regional integration in CFA

Zone because the effect of trade integration on the synchronization of the cycles is relatively low within the Zone.

Currency union failed to sustain regional integration in CFA Zone because savings are less sufficient to intensify the mechanism of risk sharing within the zone, and moreover, financial asymmetries leads to the amplification of national differences among member countries.

The magnitude of the effect of endogeneity is lower within the CFA Zone to accelerate regional integration process.

The combination of low level of trade integration, low level of cycles synchronization and low level of the phenomenon of endogeneity, does not fundamentally change the configuration of asymmetric shocks between CFA Zone countries members.

Policy implicationThe establishment of institutions and mechanisms

for risk sharing able to offset the impact of asymmetric shocks is needed.

Policymakers should accelerate the real integration within the currency union to mitigate the amplification of product instability.

Since savings are the main channel of risk sharing in CFA Zone, regional policy to raise savings and settle in consumption behavior should be adopted.

The current and upcoming currency unions in Africa should develop regional credit markets and facilitate access to credit markets.