Monetary Policy Contagion in the West African Monetary Zone

Date01 November 2019
Published date01 November 2019
Subject MatterArticles
05_FTR874219.indd Article
Monetary Policy
Foreign Trade Review
54(4) 375–398, 2019
Contagion in the West
© 2019 Indian Institute of
Foreign Trade
African Monetary Zone
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DOI: 10.1177/0015732519874219
Moses K. Tule1
Taiwo Ajilore2
Augustine Ujunwa2
The study utilized quarterly time series data for Nigeria and three selected West
African Monetary Zone (WAMZ) countries for the period 1980–2016 to ver-
ify whether monetary policy shocks emanating from Nigeria are an important
source of macroeconomic fluctuations in WAMZ economies. The study com-
plemented the Global vector autoregressive method with the Diebold–Yilmaz
(2009) connectedness weights computation for the analysis. Inferences from
generalized impulse response function (GIRF) analysis indicated that an unantici-
pated Nigerian monetary policy shock depreciates the Nigeria–USA exchange
rate, stimulates growth, decelerates inflation and expands the money stock in
the short run for Nigeria. In Ghana, Nigeria’s monetary policy shocks similarly
depreciates the exchange rate, slows growth with high inflationary impact in
the short run. In the Gambia, unanticipated shocks emanating from Nigeria
strengthens the Gambia–USA exchange rate, depresses growth and inflation-
ary pressures. Sierra Leone shares the appreciation of its currency with the
Gambia, in addition to an economic expansion and rising inflation. Money supply
also increases to accommodate the expanding demand. These results validated
the thesis that there exist considerable geographical linkages within the WAMZ
regions through which macroeconomic fluctuations are transmitted. For policy,
monetary authorities in the region should collectively address the question of
how to stabilize the economy in response to monetary policy shocks emanating
from Nigeria.
1 Monetary Policy Department, Central Bank of Nigeria, Abuja, Nigeria.
2 International Economic Relations Division, Monetary Policy Department, Central Bank of Nigeria,
Garki Abuja, Nigeria.
Corresponding author:
Taiwo Ajilore, International Economic Relations Division, Monetary Policy Department, Central
Bank of Nigeria, Plot 33, Abubakar Tafawa Balewa Way, Central Business District, Cadastral Zone,
Abuja, Federal Capital Territory, Nigeria P.M.B. 0187, Garki Abuja 900211, Nigeria.

Foreign Trade Review 54(4)
JEL Codes: E52, E32, E65, F02
Monetary integration, contagion, WAMZ zone, GVAR
The lessons of the global financial crisis had motivated phenomenal research
enquiries on interdependencies of global economies, exemplifying how shocks
emanating from a dominant country can rapidly propagate beyond the borders to
affect macroeconomic outcomes in other countries, and ultimately, the global
economy. The vulnerabilities of the affected countries are determined by their
exposures to international trade and other forms of financial flows from the domi-
nant economy. Given the foregoing, the focal roles of the US economy in world
trade and financial flows have rendered it the specimen for the preponderance of
literature on the transmission of macroeconomic shocks to foreign economies.
The key issues underlying prior research on international shock transmission
have been very instructive: First, the significant spillover of demand, supply and
monetary policy shocks on countries’ macroeconomic outcomes have been widely
investigated and established (see literature review). Important lessons for policy-
makers from these body of research is the need to have an handle on the nature of
international linkages and spillovers between a large and small economies, and to
devise appropriate and proactive policy response, in the absence of which,
achievement of macroeconomic and financial stability in small open economies
will remain a mirage.
In addition, authors have begun to highlight the importance of regional factors
in the transmission of shocks. Willett, Permpoon, and Wihlborg (2010) have
argued that increases in regionalization and regional integration would lead to
increasing decoupling of economic and financial market performance from devel-
opments in the advanced economies to those related to regional factors. Also, Li
(2011) finds that the proxies for global factors have become less important in
explaining macroeconomic contagion, relative to regional factors. The foregoing
suggests that research on international shock transmission will be well suited and
most relevant within regional jurisdictions.
These issues become very relevant and bear important consequences for the
conduct of monetary policy by central banks in the West African Monetary Zone
(WAMZ) region. The increased pace of advancement towards actualization of a
monetary union will imply more synchronized business cycles which would pre-
sumably mean a stronger and faster transmission of shocks across these countries.
The foregoing provides an important motivation for intra-regional policy coordi-
nation in the zone. This predisposes them to take into considerations when setting
interest rate, the interrelationships that exist between their economy and the rest
of the monetary zone. Hence, our study is intended to replicate these issues in the
relations among selected countries within the WAMZ for which, to the best of our
knowledge, such research efforts do not yet exist.

Tule et al. 377
The WAMZ is a monetary union that comprises of six countries: a relatively
dominant Nigerian economy, alongside other small open economies including
Ghana, Sierra Leone, The Gambia, Guinea and Liberia. The sheer geographical
and economic size of Nigeria within the union suggests that these other countries
will catch cold when Nigeria sneezes, just like the world economy did when the
USA sneezed during the global crisis. Relative to other member countries, the
economic dominance of Nigeria in WAMZ is obvious. It accounts for 85.6 per
cent of the zone’s GDP and 76.5 per cent of the population. Trade and financial
interdependencies with Nigeria is thus very important to these other countries.
Arising from this is the possibility of some sort of commonality between cyclical
behaviours of the Nigerian economy and the rest of the WAMZ economies.
If the goal and the commitment to a regional approach to economic develop-
ment in WAMZ are realized, it becomes important to understand the existence and
the nature of commonality of economic fluctuations between the grouping’s prime
mover, Nigeria and the other countries. This understanding is important for opti-
mal policy cooperation and coordination as well as the identification of best pol-
icy response to key developments in Nigeria’s economy and provides basis for
mutual policies to enhance economic benefits and avoid adverse shocks propaga-
tion in WAMZ countries. Consequent on the foregoing, the study examines from
a business cycle perspective, the interdependencies of WAMZ countries with
Nigeria, employing the innovations of Global vector autoregressions (GVAR)
techniques as a tool of analysis.
Following this introductory, the rest of the article proceeds as follows: In the
second section, a snapshot of the theoretical constructs underpinning the issues as
well as excerpts of empirical research on the subject is presented. The third sec-
tion provides a review of progress in trade and financial integration between
Nigeria and the rest of the WAMZ zone. In the fourth section, an outline of the
methodological procedures for the subsequent analysis intended in the study is
presented, while the fifth section discusses the results and findings from empirical
analysis. The sixth section concludes.
Literature Review
Many of the research on international transmission of real and monetary shocks
have utilized the theoretical planks developed in Mundell (1962, 1968) and Fleming
(1962), thus making the Mundell–Fleming model the workhorse and standard in
empirical works in this field. Predictions from these models remained as varied as
the varieties of contributions from the authors. The two-country Mundell–Fleming
model predicts that a tight monetary stance in a foreign country that results in for-
eign interest rates spikes, given a fixed exchange rate regime, will produce output
slowdown in both domestic and the foreign economy. On the other hand, the model
predicts that an interest rate increase that results from fiscal spending expansion
will boost foreign output but reduce domestic output. However, a flexible exchange
rate arrangement presents a contrary prediction. A monetary contraction overseas
produces expansion of domestic output and a contraction in foreign output, while
fiscal spending expansion indicates expansion in output both at home and abroad.

Foreign Trade Review 54(4)
Notwithstanding the versatility of the Mundell–Flemming model, it has been
criticized for basing its predictions on equations that are ad hoc rather than as a
result of optimizing behaviour of agents. As a response, the Keynesian econo-
mists in the 1980s provided a framework in the context of optimizing behaviours
of consumers and business firms in order to explain the short-run non-neutrality
of money. The seminal model of Obstfeld and Rogoff (1995) provides an example
of a strand of this literature. Otherwise known as the Redux model, it shows in a
simple two-country framework, how...

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