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Currency regimes, in particular the adoption of a common currency in the context of regional integration, have been in the spotlight for more than four decades. In recent years, a more intense interest in developingcountry monetary unions, especially in Africa, can be attributed to the EU’s successful launch of the euro zone. Despite extensive economic analysis and some agreement on the factors that would produce costs and benefits, economists often cannot reach a consensus on whether the benefits of a currency regime in a particular region outweigh the costs, much less a general presumption that monetary unions are necessarily a good thing.1 Nevertheless, there is considerable political support for the idea, often in the context of a desire to further regional solidarity, which suggests that the economic literature has not paid sufficient attention to the political dimension. We argue that some of the existing literature is less applicable to Africa than to Europe because Africa faces fundamental problems, such as a lack of central bank independence and severe fiscal distortions leading to overspending and pressures to monetize deficits, that are not prevalent in Europe. 33 Criteria for Currency Unions or the Adoption of Another Currency 3 1. This is in contrast to the sweeping statement by John Stuart Mill that separate currencies are a form of “barbarism” and that the common interest would require moving to a single world currency. While there are some supporters of this view (for example, Cooper, 1984), it is certainly not generally held at present. 2284-03_CH03.qxd 10/27/04 11:14 Page 33 34 criteria for currency unions The economics literature on optimum currency areas (OCAs) is derived in large part from the seminal article by Robert Mundell.2 In a nutshell, a common currency can save on various types of transactions costs, but a country abandoning its own currency gives up the ability to use monetary policy to respond to asymmetric shocks, which are shocks that impact it differently from the other countries in the union. Those costs, in turn, can be minimized by greater flexibility of the economy, in particular, through labor mobility, wage and price flexibility, and fiscal transfers. The likelihood of asymmetric shocks depends inversely on how diversified a country’s economy is and how similar its production and export structures are relative to its partners in the monetary union. The analysis, when applied to Europe, usually has assumed that institutional design issues by and large have been resolved. In particular, the central bank can be insulated by statute from having to finance government spending (in Europe, this is ensured by a no-bailout provision preventing the central bank from lending to governments, buttressed by a history of central bank independence , particularly in Germany). The main danger is that fiscal policy may indirectly put pressures on monetary policy. For instance, if a country got into trouble servicing its debt, the central bank might be led to ease monetary policy to lower the treasury’s interest costs and prevent a financial crisis. The Stability and Growth Pact to which euro zone countries have to commit themselves was aimed at minimizing that danger in Europe. Though there is considerable controversy at present about the effectiveness of the pact, and several governments have breached the deficit ceiling (3 percent of GDP), there is no immediate concern that the ECB’s independence is being put in peril. In Africa, however, the institutional challenges are at least an order of magnitude greater. Existing national central banks generally are not independent, and countries with their own currencies have often suffered periods of high inflation because those central banks have been forced to finance public deficits. Hence the interest in the African context is in whether the creation of a regional central bank can be a vehicle for solving precommitment and credibility problems that bedevil existing central banks. If so, they may be able to provide an “agency of restraint,”3 producing a central bank that is more independent and exerts greater discipline over fiscal policies than do national central banks. A further important motivation for monetary union in Africa is to provide impetus for greater regional integration. Monetary union is often seen as an important symbol of regional solidarity, one that is likely to reinforce popular (and hence political) support for regional initiatives. In Europe that aspect 2. Mundell (1961). 3. Collier (1991). 2284-03_CH03.qxd 10/27/04 11:14 Page 34 [3.17.203.68] Project MUSE (2024-04-26 08...

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