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Regional Integration Policy Paper No.3

13-Oct-2014

The African Regional Economic Communities (RECs) are committed to gradually establishing an economic union in their respective sub-regions in accordance with the objectives of the Abuja Treaty. The RECs pursue a gradual objective geared towards attaining the ultimate stage of economic and monetary union.There is abundant economic literature on the costs and advantages of an economic and monetary union at the theoretical and empirical levels. Traditional literature on the Optimal Currency Areas (OCA) theory , developed by Mundell (1961) and McKinnon (1963), posit that member countries of a monetary union will benefit from lower transaction costs emanating from trading goods and assets in foreign currency.

Recent empirical data highlight the significant positive impact of monetary unions on trade (Rose 2000, Glick and Rose 2001) and income (Frankel and Rose 2002). The other possible advantages in terms of macro-economic efficiency for joining a monetary union are the elimination of (or significant reduction in) nominal exchange rate volatility and hence lower interest rates, low real exchange rate volatility, greater financial integration.

However, the advantages in terms of macro-economic efficiency of a monetary union may be offset by reduced macro-economic flexibility. Countries joining a monetary union lose their ability to stabilize production through an independent monetary policy and are constrained to relinquish the flexibility of their nominal exchange rate. To sum up, in accordance with the traditional approach to the OCA4 theory, it is more advantageous for countries with very close trading and financial ties with foreign countries to join an OCA than for countries with asymmetric business cycles (Artis and Toro 2000). However, it is widely admitted that the net advantages of belonging to a monetary union are not the same for all member countries.

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