Abstract

This paper investigates the potential costs of membership in a monetary union. We quantify the cost by examining the degree of exchange rate variability of WAMZ^α member countries. We took a closer look at exchange rate variability since 2000 (the run-up period). To put it differently, we examined whether member countries exchange rate variability has increased as they prepare to enter into a monetary union. The main hypothesis to be tested in this paper is: Has the preparation to enter into a monetary union led to an increased cost to the zone? In order to address the question, we assessed the costs of membership in WAMZ zone using real exchange rate (RER) variability. We used panel data, general least squares (GLS) and single equation to estimate real exchange rate misalignment of each country from 1980 to 2005. This allowed us to assess the cost of WAMZ membership since the run-up period (2000). Using both real and monetary factors, we assessed which variable affects real exchange rate (RER) variability the most and the behavior of these variables since the run-up period. The empirical result shows that real exchange rate variability has increased substantially across WAMZ zone in recent years (2000 to 2005). We concluded that the road to monetary union has so far imposed high cost to members and it highlights the need for member countries to level the playing field by putting their macroeconomic fundamentals in order before entering into monetary union.

Key words: Monetary union, exchange rate, West African monetary zone.