{UAH} Will the Nike approach yield us a monetary union that works or a Eurozone mess? - Comment - www.theeastafrican.co.ke

http://www.theeastafrican.co.ke/OpEd/comment/Will-the-Nike-approach-yield-us-a-monetary-union/-/434750/2111460/-/116tjc4z/-/index.html

Will the Nike approach yield us a monetary union that works or a Eurozone mess? - Comment

Don't we all love Dr Pangloss, a key character in Voltaire's 1762 satirical classic, Candide, who had an incurable sense of optimism?

Dr Pangloss touted his credentials as a self-professed optimist by espousing to all who cared to listen a thesis that they lived "in the best of all possible worlds" and that "all is for the best" in this best of all possible worlds.

That is why when the five East African Community heads of state appended their signatures to the Protocol for the Establishment of the East African Monetary Union during their November 30, 2013 Summit in Kampala, it was Pangloss that was on our minds, not Greece.

It is easy to understand why. This was an act beyond symbolism. For a bloc whose integration has moved steadfastly to a Common Market, a framework towards the penultimate level of the EAC integration agenda is clearly as logical as it is an opportunity for introspection.

The ambition of the EAC partners to have a monetary union has been obvious for as long as their integration agenda has existed. What passes as credible debate so far regarding the monetary union has been its cost-benefit analysis.

This is an old debate, pioneered by Economics Nobel Laureate Robert Mundell five decades ago.

The key advantages underlying the EAC's zeal for a single currency are lower transaction costs and the elimination of exchange-rate volatility among the partners.

The overwhelming conviction is that these advantages will more than compensate for the disadvantages — loss of an independent monetary policy and the use of the exchange rate as an economic policy instrument.

The proof of the pudding is in the eating, so it will take an economic jolt for one to determine the extent to which the advantages surpass the disadvantages.

If the shocks are symmetrical among the economies in the monetary union, then it will be able to counter them and the economies adjust to desirable positions.

The opposite is when the shocks are asymmetrical and unrelated, a scenario where the cost of adopting a monetary union is much higher given that each economy needs a different monetary policy response. It is reasonable to assume that at the core of the protocol are areas of co-operation aimed at addressing asymmetrical shocks.

Granted, asymmetric shocks cannot be avoided. If such shocks are small, then the loss of an independent monetary policy may not be too costly. But if they are not, then the task is to ensure that the economy in question is able to adjust quickly and smoothly to return to stability.

How do you ensure that there is quick and smooth adjustment? Take a scenario where two EAC partners are hit by adverse shocks with unemployment rising in one and falling in another.

More flexibility in both labour and wages will facilitate adjustment. I can only assume that this aspect has been taken care of under the EAC Common Market that allows for free labour movement within the bloc. I use the word assume advisedly because there have glitches on the labour movement front thus far.

What of supply disturbances? It is here that fiscal policy enters the equation. The economies subjected to supply disturbances will obviously not sit on their hands and watch but will exercise their sovereign mandate of restoring a desirable economic order by way of expenditure and tax measures.

As the experience of Greece in the Eurozone has shown us, sovereign fiscal positions in a monetary union need to be taken while bearing in mind the situation in the other economies in the bloc.

It is tempting to argue that the essence of having an agreed level of fiscal deficit — among other convergence parameters such as levels of debt, foreign currency reserves and inflation positions — is to address fiscal policy-related challenges in monetary union. This is the especially the case given that the EAC monetary union will not be accompanied by a fiscal union.

Necessary as that may be, though, it is far from sufficient, unless there is some analysis of the unbundled budgets of the respective economies in the bloc to determine how the proposed expenditure is to be financed.

In the East African case, there are glaring disparities in the budget financing mechanisms, with some economies routinely having more than a quarter of their budgets externally financed.

But several studies indicate that the Eurozone – evidently the EAC benchmark – was never what Mundell called an "optimal currency area." But it went ahead with the experiment.

Does it matter that they did? Ask the British why they stayed out of the euro, a question that has been conspicuously missed in the debate on the EAC monetary union.

The British economy would have been among the first economies to qualify to join the euro based on the Maastricht criteria — equivalent to our convergence criteria in the protocol.

Instead its Treasury decided to spend the initial years of the seven-year transition period — the equivalent of the 10 years under our protocol — to respond to five tests set out by the Chancellor of the Exchequer.

These tests, which speak directly to the question of an optimal currency area, were: The convergence test (are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis?); the flexibility test (if problems emerge, is there sufficient flexibility to deal with them?); the investment test (would joining the euro create better conditions for firms making long-term decisions to invest in Britain?); the City test (what impact would entry into the euro have on the competitive position of the UK's financial services industry, particularly the City's wholesale markets?); and the jobs test — will joining the euro promote growth, stability and a lasting increase in jobs?

Its assessment, based on 18 papers that the British Treasury published, was that "neither flexibility nor convergence are sufficient at present to make joining the euro in the near future desirable." This was evidently an informed position.

None of the East African economies needs to go the British route if the inclination is Panglossian.

In any case, a monetary union is as much a political process as it is economic, in which case the strategy will be one that economist Barry Eichengreen calls the Nike strategy: Just do it! If we go Nike, we could have played to the symbolism that a unified East Africa is a good idea.

But this has to be weighed against the views of those who ask whether a monetary union should be pursued only if some form of fiscal union is also taken on board as a critical component.

To them, if the two are not considered as two sides of the same coin, then a there is good case for not going the monetary union way. The euro model is their exhibit, and their submission could well be that going Nike will be rejecting the lessons of experience in favour of delusions of grandeur.

Jared Osoro is the director of the Kenya Bankers Association Centre for Research on Financial Markets and Policy.

Will the Nike approach yield us a monetary union that works or a Eurozone mess? - Comment - www.theeastafrican.co.ke
http://www.theeastafrican.co.ke/OpEd/comment/Will-the-Nike-approach-yield-us-a-monetary-union/-/434750/2111460/-/116tjc4z/-/index.html