The East African Community: how ready is it for a monetary union by 2012?

Abstract

The study investigates the readiness of the East Africa Community (EAC) to form a monetary union by the end of 2012 using 1980-2010 data. The problem investigated is the fact that a monetary union is not an easy integration to manage especially if the economies do not meet preconditions for monetary integration. The warning signals on the negative externalities of a MU can be seen from the current problems of the European Union (EU). This raises justified fears on the effects of a MU.

The study uses inflation rate and interest rates convergence and stationarity to assess the readiness. Augmented Dickey Fuller (ADF) test is used to test for convergence while Kwiatkowski-Phillips-Schmidt-Shin (KPSS) test is used to test for stationarity of the inflation rates differentials and interest rate differentials.

The study also uses the granger causality test to analyze the relationship between the inflation rates and lending rates for each country and further uses the correlation coefficients to detect the degree of association among the inflation rates and interest rates in the region. The study establishes that the inflation rates of the region have converged to the EAC average but the interest rates differentials have not converged.

There are also low correlations among the lending rates and inflation rates in the region. Inflation rates granger cause lending rates and lending rates do not granger cause inflation rates indicating that the monetary policy is not as effective as it should be in stabilizing inflation rates in the EAC. The overall assessment shows that the community needs more time before it meets the preconditions for making a MU.