Abstract

This paper assesses plans of the East African Community (EAC) to create a single currency for the five countries making up the region, and considers how best to achieve it. While the benefits of lower transactions costs from a common currency may be significant, countries will also lose the ability to use monetary policy to respond to different shocks. Evidence presented shows that the countries differ in a number of respects, facing asymmetric shocks and different production structures. Countries have had difficulty meeting convergence criteria, most seriously as concerns fiscal deficits. Preparation for monetary union will require effective institutions for macroeconomic surveillance and enforcing fiscal discipline, and euro zone experience indicates that these institutions will be difficult to design and take a considerable time to become effective. This suggests that a timetable for monetary union in the EAC should allow for a substantial initial period of institution building. In order to have some visible evidence of the commitment to monetary union, in the meantime the EAC may want to consider introducing a common basket currency in the form of notes and coin, to circulate in parallel with national currencies.

Key words: EAC monetary union, fiscal surveillance, optimum currency areas, parallel currencies, regional integration.

Abbreviation

JEL Classification Numbers: E42, E58, E61, F33, F55.