Journal Issue

4. Conclusions

Paulo Drummond, Ari Aisen, Emre Alper, Ejona Fuli, and Sébastien Walker
Published Date:
July 2015
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This paper identifies the degree of susceptibility of the EAC economies to asymmetric shocks; assesses the value of the exchange rate as a shock absorber for these countries; and reviews adjustment mechanisms that would help ensure a successful experience under the monetary union.

Our findings reveal that despite some similarities in the structures of their economies, country-specific shocks have been prevalent in the last two decades, with EAC economies remaining susceptible to asymmetric shocks. Additionally, declining dispersion of growth rates across countries suggests only a gradual move toward economic convergence in the last decade. Cluster analysis would seem to indicate that from an optimal currency area perspective, dissimilarities remain large.

The exchange rates appear to absorb real asymmetric shocks in all cases save that of Burundi, highlighting the need for additional tools to stabilize the EAC economies once country-specific (nominal) exchange rates are no longer available as shock absorbers. Our results also indicate that, while exchange-rate shocks do not seem materially to affect output, they are a source of disturbances to inflation, suggesting that EAC countries should press ahead on their journey to modernize their monetary policy frameworks.

While the analysis draws on recent experience, backward-looking measures are imperfect for a forward-looking assessment. What appear to be long-term structural differences may rapidly disappear in the run up to the establishment of the monetary union. The adjustment of economic structures and performance could speed up, and deeper economic integration can lessen, the probability of occurrence of asymmetric shocks. Moreover, the asymmetric shocks could be policy-induced rather than exogenous and, as a result, loss of policy independence may not always be necessarily costly.

Nevertheless, EAC countries will still likely continue to be exposed to these shocks for quite some time, requiring policy responses. Going forward, as highlighted by the experience in other currency unions, it will be key for the EAC to continue to direct its efforts to design and put in place adequate mechanisms that can help member countries to adjust to future shocks once the Monetary Union is consolidated. This includes the usual levers to mitigate costs of common monetary policy such as labor and capital mobility, price, and wage flexibility, as well as various risk-sharing mechanisms, including fiscal. These levers should be agreed among member countries before the introduction of the single currency to reduce risks and signal early commitment to macroeconomic stability.

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