A monetary union has been proposed for Africa. However, there are several important questions involving national economic independence and economic efficiency that should be considered seriously by those contemplating such a union. That the political opinion and public opinion in so many European countries endorsed a monetary union despite the overwhelming loss of national independence, especially in the area of monetary policy, is striking in view of the obvious structural problems a monetary union engenders. Periods of economic weakness and periods of increasing unemployment usually impel the corresponding Central Bank to follow low interest rate policies and increased money supply ( significant exceptions occur when the IMF prescribes the opposite policies for certain countries in economic distress although countries like the United States tend to do monetary expansion during recessions ). The idea is to counteract slack in the economy ( a condition where actual output falls short of maximum possible output due to coordination failure between demand and potential supply ) by spurring demand ( as measured in the country’s currency ). The idea, a keystone of Keynesianism, has its detractors. For example, there are those who argue that money supply policy measures should be completely nullified by price adjustments in the economy. However, Central Banks do follow this kind policy, for example, in the United States. A weak economy is usually accompanied by deflation or very low inflation. So, there is not much to lose in terms of inflation by following these policies.
What could prove to be more important for a monetary union is the converse side of this policy. Namely, what happens if a Central Bank shrinks the money supply. Shrinking of money supply can sometimes lead to deflationary expectations and deflationary spirals, and can create slack in the economy and exacerbate unemployment. There is no guarantee that any particular monetary tightening measure by the European Central Bank, for example, is going to be right for all countries in the monetary union. Particular countries can get pushed into higher unemployment as a result of such steps.
Monetary tightening can lead to recessions in particular countries, put pressure on fiscal balances, drive up debt-to-GDP ratios and necessitate painful bailout conditions, when an independent central bank could have nipped the economic weakness in the bud by following low interest rate policies. The economies of individual countries will have to react to monetary changes by any central bank. The danger of deflationary spirals and irrational recessionary dynamics being set in motion because of a mismatch between central bank monetary policy and local economic realities is all too real.
The transaction costs due to currency exchange may be a constant kind of low-level inefficiency. However, the possible turmoil due to mismatch between central bank policy and local economic can have lasting impacts on a country’s economy. The actual inefficiency due to these can be way higher. It can impoverish entire sections of the country’s population. It can render entire sectors of the economy uncompetitive vis-à-vis global competition when an independent Central bank could have come to the rescue of these sectors.
Countries with independent Central banks also run into economic impasses where they need bailouts. However, anyone contemplating a monetary union in Africa needs to take into account the all-too-real possibility that a centralized monetary system can either lose touch with local economic realities or can find it impossible to accommodate local inhomogenities in its global monetary policies. Larger African countries may well dominate the agenda at the central bank and smaller African countries can be left to the whims of an insouciant central bank. Bailout packages will most probably be negotiated and extended in their own sweet time, well after economic activity has hemorrhaged in the country and well after fiscal balances have been thrown completely off-kilter due to recessions that a national central bank could have counteracted or mitigated much faster. The idea is not to let monetary problems become the source of growth, output and fiscal problems in the first place. And that is the danger from pushing for a monetary union of countries which are non-homogenous in their economic activities and whose output and employment dynamics are unlikely to be in sync with each other at all times.
A monetary union may have some advantages due to the larger scale when it comes to unscrupulous currency traders trying to manipulate currencies. However, appropriate policy measures can be devised to prevent excessive manipulation of a country’s currency. While currency speculation and currency attacks are real possibilities, fundamentals should prevail if deft enough handling of national economic policy is done. Also, there is no guarantee that currency manipulators cannot attack a common African currency. It is better to control the currency market and live with some low-level inefficiency on a constant basis than to be faced with large economic disruptions due to co-ordination failures between an African central bank policy and the needs of the national economies.
by C. Jayant Praharaj
What could prove to be more important for a monetary union is the converse side of this policy. Namely, what happens if a Central Bank shrinks the money supply. Shrinking of money supply can sometimes lead to deflationary expectations and deflationary spirals, and can create slack in the economy and exacerbate unemployment. There is no guarantee that any particular monetary tightening measure by the European Central Bank, for example, is going to be right for all countries in the monetary union. Particular countries can get pushed into higher unemployment as a result of such steps.
Monetary tightening can lead to recessions in particular countries, put pressure on fiscal balances, drive up debt-to-GDP ratios and necessitate painful bailout conditions, when an independent central bank could have nipped the economic weakness in the bud by following low interest rate policies. The economies of individual countries will have to react to monetary changes by any central bank. The danger of deflationary spirals and irrational recessionary dynamics being set in motion because of a mismatch between central bank monetary policy and local economic realities is all too real.
The transaction costs due to currency exchange may be a constant kind of low-level inefficiency. However, the possible turmoil due to mismatch between central bank policy and local economic can have lasting impacts on a country’s economy. The actual inefficiency due to these can be way higher. It can impoverish entire sections of the country’s population. It can render entire sectors of the economy uncompetitive vis-à-vis global competition when an independent Central bank could have come to the rescue of these sectors.
Countries with independent Central banks also run into economic impasses where they need bailouts. However, anyone contemplating a monetary union in Africa needs to take into account the all-too-real possibility that a centralized monetary system can either lose touch with local economic realities or can find it impossible to accommodate local inhomogenities in its global monetary policies. Larger African countries may well dominate the agenda at the central bank and smaller African countries can be left to the whims of an insouciant central bank. Bailout packages will most probably be negotiated and extended in their own sweet time, well after economic activity has hemorrhaged in the country and well after fiscal balances have been thrown completely off-kilter due to recessions that a national central bank could have counteracted or mitigated much faster. The idea is not to let monetary problems become the source of growth, output and fiscal problems in the first place. And that is the danger from pushing for a monetary union of countries which are non-homogenous in their economic activities and whose output and employment dynamics are unlikely to be in sync with each other at all times.
A monetary union may have some advantages due to the larger scale when it comes to unscrupulous currency traders trying to manipulate currencies. However, appropriate policy measures can be devised to prevent excessive manipulation of a country’s currency. While currency speculation and currency attacks are real possibilities, fundamentals should prevail if deft enough handling of national economic policy is done. Also, there is no guarantee that currency manipulators cannot attack a common African currency. It is better to control the currency market and live with some low-level inefficiency on a constant basis than to be faced with large economic disruptions due to co-ordination failures between an African central bank policy and the needs of the national economies.
by C. Jayant Praharaj