Exchange rate policy options for Namibia

The thesis assesses the costs and benefits of Namibia's membership of the CMA to determine whether the CMA is an optimal currency area at least from the perspective of Namibia. This issue is examined from two main perspectives: (a) whether real exchange rate (RER) adjustment is frustrated by the inability to use the nominal exchange rate as an instrument of adjustment. Evidence of persistent RER misalignment may be seen as a necessary condition for an independent nominal exchange rate regime, however, it is not sufficient.(b) In this case, we examine whether nominal devaluations will have sustained effects on RER adjustment, given Namibia's structural features, such as the high degree of openness and a small nontradable sector. An equilibrium RER for Namibia is estimated using a single equation model of RER determination. The model is used to compute RER misalignments to determine whether there are sustained long periods of misalignments. To test whether nominal exchange rates can be effective in changing relative prices, a simple model was developed to measure pass-through of foreign price and exchange rate changes to domestic prices and wages. This provides useful information regarding whether nominal devaluations can be sustained. The results show that RER misalignments have been small, while the extent and speed of pass-through is complete and instantaneous for most items, suggesting that nominal devaluations in Namibia are not likely to have real effects. Even if it was the case that monetary autonomy cannot be supported on grounds of affecting relative prices, it may nevertheless be important for Namibia to pursue an independent exchange rate strategy. To examine this possibility, the analysis was extended by looking at costs and benefits of OCAs which do not rely on the ability to change relative prices. Benefits arising from savings on transactions costs and on foreign exchange reserves amounted to 3.8% and 2.4% of GDP, respectively. Further, we demonstrated that past "shocks" between Namibia and South Africa were highly correlated. The findings of the thesis suggest that the CMA is an optimal exchange regime for Namibia.