Prospective Impactof the Proposed Monetary Union in East African Community: Gravity Model Approach

Abstract

Considering the significance of a monetary union, the five countries of East African Community have had a quest and interest of forming the union. The Theory of Optimum Currency Area (OCA) is the most instructive construct in the establishment of such a financial union. The theory has listed out several important criteria that need to be fulfilled before the establishment of monetary union. This study examined two aspects of the monetary union, that is, the suitability of the OCA theory as a basis for the feasibility of the proposed monetary union and the prospective impact of trade on economic growth in the context of the East African Community (EAC) countries. The study sought to determine: symmetry of monetary shocks; parity of inflation rates; parity of fiscal deficit, similarity of public debt, similarity of real gross domestic product and degree of openness; and the potential impact of monetary union of trade on economic growth among the five members of East African Community; Uganda, Burundi, Kenya, Rwanda and Tanzania. The research was exploratory by design. The target population were the five EAC countries. Panel data was employed using data on quarterly basisover the period 2000Q1-2016Q4. The study used Gravity model. The Gravity Model indicated monetary union could be formed by; Tanzania, Kenya, Uganda and Rwanda; Kenya, Uganda, Burundi and Rwanda; Tanzania, Kenya and Rwanda; Tanzania, Kenya and Burundi; and Kenya, Uganda and Burundi albeit negative elasticity indicating that monetary union reduced trade as compared to none union members. The previous per capita had a significant and positive impact of economic growth for the EAC countries that could form a monetary union. This study provided the insight of the possibilities of some EAC countries forming a monetary union. The policy makers in the EAC countries could concentrate in adapting unfulfilled macroeconomic convergence criteria; strengthening the cooperation in the monetary and exchange rate policy; increasing the intra-regional trade and regional policy co-ordinations in order to ensure a foreseeable monetary union in EAC.