Costs and benefits of using the Rand as common currency in southern Africa

Abstract: Do monetary unions between developing economies support sustainable economic development for the members? Previous research has only considered traditional research methods to examine costs and benefits of monetary unions in developing regions. This thesis applies new measures to determine how the operation of institutions encounters specific problems of developing economies for the case of the Common Monetary Area in southern Africa. Additionally, this thesis investigates costs from asymmetric economic shocks and benefits from intensified trade between the members and their evolution over time. The common component of economic shocks in Namibia, Lesotho, and Swaziland with South African economic fluctuations is measured using the variance decomposition of forecast errors in a structural VAR model. Shocks are found to hit the CMA area asymmetrically which has not changed since 1960. The analysis of bilateral trade data since 2000 shows no common currency trade-enhancing effect between the CMA members compared to trade with other economies in the region. Costs for the small members arise from the asymmetric institutional design and the South African Reserve Bank’s bias towards the South African economy when setting monetary policy for the area. Benefits occur due to the adopted credible low-inflation reputation of the SARB, the disciplining effect on the state budget and lower interest on state debt. Moreover, the small CMA members profit from the opportunity of taking on debt in their domestic currency. The analysis demonstrates that further research on monetary unions will need to consider new aspects of costs and benefits that address the particular situation of developing economies.