Monetary unions can generate potentially large benefits for African countries through increased trade flows, macroeconomic stability, and economic growth. Their establish-ment, however, requires facing a broad set of challenges.
On the institutional side countries must realize that a common central bank must be independent of national fiscal authorities and that its mandate must be clearly stated in terms of a nominal anchor (internal or external). Monetary stability will also require appropriate banking supervision. Whether this is the responsibility of the common central bank or of national authorities depends on the degree of segmenta-tion of nasegmenta-tional banking systems. Supervision should be coupled with appropriate legislation to enforce prudent lending behaviour. This is particularly important in a context where asymmetric information between lenders and borrowers can lead quickly to a deterioration in the average quality of borrowers and so to a rising share of nonperforming loans. A clear decision also needs to be made on what institution will be the lender of last resort, since the shift of this function from national central banks to the common central bank is not automatic. The sustainability of monetary integration will depend crucially on mechanisms for resolving potential political economy conflicts.
For successful transition to a monetary union, participating countries should develop an appropriate policy mix, with specific commitments to low inflation and sound fis-cal policies to achieve convergence. Performance so far has been mixed. The failure to hit macroeconomic convergence targets is due both to economic factors and to gaps in the institutional design of the criteria. Criteria constrain the policy choices of national governments only to the extent that they are credible and enforceable, with clearly spec-ified deadlines—not always the case. Furthermore, membership in different regional economic communities with different criteria reduces the pressure to introduce eco-nomic policy reforms. The need to monitor ecoeco-nomic policy compliance also requires the creation of mechanisms of multilateral surveillance, which can facilitate technical cooperation across countries.
Supervision should be coupled with appropriate legislation to enforce prudent lending behaviour
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Development of capital markets and deepening of financial intermediation are crucial to the mobilization of resources for growth and development. The progressive inte-gration of financial markets that occurs with monetary inteinte-gration requires harmo-nization of procedures across countries. Harmoharmo-nization also reduces the likelihood of differences arising across countries in the transmission mechanism of the common monetary policy. Integrating local financial markets into the globalized financial sys-tem requires that regional standards be raised to meet international standards.
Notes
1. Examples of monetary cooperation include agreements for balance of payments financing, regional payments, limited currency convertibility, mutual currency man-agement, parallel currency unions, and monetary unions.
2. For an exhaustive recent treatment of optimal exchange arrangements see Mussa and others (2000).
3. Thus, macroeconomic convergence is not defined in terms of the degree of symmetry (or asymmetry) of shocks across countries.
4. Dore and Masson (2002) point out that the fiscal consolidation trend reverted in 1998–2001 because of terms of trade deterioration and unfavourable movements in the business cycle. Nevertheless, the overall fiscal performance of countries in the zone can be regarded as positive.
5. Alesina and Grilli (1992) provide a clear example of policy conflicts due to differ-ent policy preferences across countries in a monetary union.
6. See Drazen (2000, Ch. 12) for an analysis of the political economy of the European Monetary Union.
7. See, for instance, World Bank (2002) for a discussion of financial integration in EAC.
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