Assessing the feasibility of monetary union in terms of business cycle synchronization in West Africa: An Application of Factor Augmented Vector Autoregressive Model (FAVAR)

ABSTRACT: This paper examines the nature of business cycle synchronization among 14 West Africancountries. Six macroeconomic variables were selected from each country and 4 regional shocks were identifiedthat include regional output shock, regional exchange rate shock, regional monetary policy variable shock, restof the world shock, and two external shocks from crude oil prices and World GDP. A factor Augmented VectorAutoregressive Model (FAVAR) was employed to achieve the objectives of the study and data used in theanalysis spanned from 1980 to 2016. The result from the impulse response function reveals the evidence ofsimilar response to the same shock among majority of the countries at different horizons. The business cyclesynchronization was examined through each country’s contribution to fluctuation at the forecasted error,however, the result indicates that majority of these countries are synchronous and the success of the currencycould not be ruled out. Thus, the study concludes in favor of single currency.

Key Word: Monetary union, Economic Community of West African States, Optimum Currency Area, FactorAugmented Vector Autoregressive, monetary policy, business cycle