A Single Currency for Africa?
| Author | Paul Masson/Catherine Pattillo |
| Position | Research Fellow/Senior Economist at the IMF |
| Pages | 9-15 |
Page 9
The article draws largely from a new book by the authors, The Monetary Geography of Africa, published by the Brookings Institution.
THE GOAL of a common African currency has long been a pillar of African unity, a symbol of the strength that its backers hope will emerge from efforts to integrate the continent. Although the prospect of a single African currency had been mooted as a goal of the Organization for African Unity (OAU), created in 1963, the project was given renewed priority in 2001 when the OAU's 53 member states agreed to transform the intergovernmental organization into the African Union (AU)-retaining its predecessor's dedication to political and economic unity while taking on a broader mandate to meet the challenges of globalization. In August 2003, the Association of African Central Bank Governors announced that it would work for a single currency and common central bank by 2021.
The AU's strategy relies on the prior creation of monetary unions in five existing regional economic communities (see Map 1). These regional unions would be an intermediate stage, leading ultimately to their merger, creating a single African central bank and currency. A plan with such widespread economic and political consequences throughout the continent deserves careful examination. However, to date, very little research has been done on its desirability and feasibility. For that reason, we undertook such an assessment, using a unique model that integrates the idea of asymmetry of shocks-shocks that impact a country differently from the other countries in a monetary union-with the absence (due to weak governance) of institutions effectively able to insulate the central bank from pressures to finance deficits and produce over-expansionary monetary policies. Our findings-which appear in a book just published by the Brookings Institution-raise serious questions about the feasibility and desirability of a full African monetary union. However, selective expansion of the existing monetary unions could be used as a means of inducing countries to improve their policies (see Map 2). Employing peer pressure in this
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way is consistent with the principles of the New Partnership for African Development (NEPAD)-adopted in 2001 by AU members with the aims of improving economic policies, stimulating growth, and fostering good governance in African countries-and could augment the effectiveness of this process.
There are two principal reasons for the enthusiasm for African monetary union-both of which transcend the conventional economic aims of higher growth and lower inflation. First, it is clear that the euro's successful launch has stimulated interest in monetary unions in other regions. But it is sometimes forgotten just how long the road actually was for Europe. In Africa, fiscal problems are much more severe and the credibility of monetary institutions is more fragile. If the process of creating appropriate institutions was so difficult for a set of rich countries with highly competent bureaucracies that have cooperated closely for more than 50 years, then, realistically, the challenge for African countries must be considered enormous.
Second, African monetary union has been motivated by the desire to counteract perceived economic and political weakness. For example, regional groupings could help Africa in negotiating favorable trading arrangements, either globally (in the World Trade Organization context) or bilaterally (with the European Union and the United States). While the objective of regional integration seems well founded, it is unclear whether forming a monetary union would contribute greatly to it. A currency that is ill managed and subject to continual depreciation is not likely to stimulate pride in the region or give the member countries any clout on the world stage.
What does the economic literature, derived largely from Robert Mundell's seminal 1961 article setting forth the "theory of optimum currency areas," have to say? In a nutshell, a common currency can save on various types of transaction costs, but a country abandoning its own currency gives up the ability to use national monetary policy to respond to asymmetric shocks. These costs, in turn, can be minimized by greater flexibility of the economy. That is, a country relinquishing its national monetary sovereignty may nevertheless be able to adapt to these shocks, mainly through labor mobility, wage and price flexibility, and fiscal transfers. The likelihood of a country experiencing asymmetric shocks depends on how similar its production and export structures are relative to its partners in the monetary union.
Euro-area countries have much better communication and transportation links than African countries, so Africa may not expect the same gains from economies of scale and reduction of transaction costs, even in proportion to its economic size, that are expected to result from Europe's monetary union. Because they are highly specialized, African countries suffer large terms of trade shocks, which often do not involve the same commodities and hence do not movePage 11 together. Neither structural features of the economy nor available policy tools hold much promise for facilitating adjustment to these shocks. Labor mobility in some African regions is higher than in Europe but is still limited and politically sensitive. And currently little scope exists for intra-African fiscal transfers.
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The analysis, when applied to Europe, usually has assumed that institutional design issues have largely 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...
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