Adverse asymmetric shocks within a monetary union pose a serious problem to jobs and production if prices and wages are rigid and capital and labour are immobile. For a small open economy like Rwanda, the most important price is the value of the Rwandan franc. Even though prices and wages are flexible in Rwanda, the inability to adjust the exchange rate if it were in a currency union would imply that the adjustments to the shock operate primarily through quantities - jobs and output volumes – as distinct from prices. This problem would be compounded by not fully mobile labour.
Asymmetric shocks in the EAC are commonplace. Studies of business cycles in the EAC find them still quite dissimilar. Inflation has been high and volatile over the past decade with frequent country-specific shocks and similar conclusions apply to the money stock. While all countries within the EAC are relatively open for international trade, only a small portion is within the Community. Hence to the extent that changes to the terms of trade vary across the EAC countries, these can be an important source of asymmetric shocks. From Rwanda’s point of view the considerable volatility in world market prices of tea and coffee is a cause for concern in this respect as these two commodities make up 35 per cent of Rwanda’s export. Another potential source of asymmetric shocks is natural resource discovery – such as the discovery of large deposits of oil in Uganda.
The Benefits of Monetary Union
Since the EACB is bound to be independent, have clear objectives, and be accountable only to the purposes of its charter, one would expect a more stable monetary policy in EAMU than in any single EAC country. This would likely reduce the variability of inflation rates and stimulate convergence in other nominal variables.
Naturally, whether the EACB will be able to deliver on this depends on its mandate and the strength of its political backing from the governments of the country member states.
Following the example of the EU, the EAC has established a set of economic convergence criteria that have to be fulfilled before a state can become a member of the EAMU. However, these convergence criteria have a number of weaknesses. In particular, there is a lack of definitions of several of the concepts and some of the outcomes are hard or impossible for national governments to control.
Paul De Grauwe, a leading expert on monetary integration, argues strongly that it is necessary to have a well-functioning supranational institutional structure in place to establish and run a monetary union. However, building the necessary institutions is a complicated and difficult process, and a long of political negotiations and technical work will be needed before the EAMU can be launched.
Ideas for Growth
Monetary integration in the EAC may well have long-term benefits in the form of lower transaction costs, increased trade, and greater macroeconomic and monetary stability.
However, the exposure of the region to shocks that affect countries differently raises the risks of adopting a common currency prematurely. This is particularly true if, as the ECB warns, the necessary pre-conditions are not met.
This should not dissuade the EAC from deepening collaboration on elements of the convergence agenda can have considerable pay-offs. Recommendations included in the note are to:
- Improve macroeconomic coordination, particularly in monetary and exchange rate policies.
- Deepen collaboration on reducing restrictions on trade in goods and services – through facilitation, reducing NTBs, and adopting common regulation and standards – would promote regional integration and contribute to regional price stability.