Abstract:
This thesis operationalizes the theory of optimum currency areas, which describes
the preconditions (criteria) that countries must fulfill prior to forming a monetary
union. In light of the different dimensions of the theory that are examined, the
empirical findings from the four papers in this thesis seem to favor forming a
monetary union among East African Community (EAC) partner states. Hence, the
findings are important for EAC policymakers, as they decided to participate in a
monetary union by 2024.
The first paper uses a gravity model to determine to what extent membership
in the EAC has affected intraregional trade. One common argument is that if there
is not much trade between EAC member countries, there is no interest in forming
a monetary union. The paper implements the fixed effect filter estimator, which
uses a two-step approach and has better performance than the standard fixed effect
estimator. The empirical findings in this paper show that EAC membership has a
positive and significant effect on intra-trade among member countries. The
second paper investigates business cycle synchronization and core-periphery
patterns. Greater synchronization is needed for an easy transition towards
monetary union. Unlike previous studies, this paper uses wavelet decomposition,
a powerful tool for analyzing the comovement of business cycles. It is found that
business cycle synchronization is more significant for Kenya, Tanzania, and
Uganda, the countries that also form the core of the East African Monetary Union.
The link between business cycle synchronization and trade intensity among
EAC countries is established in the third paper. This analysis is relevant, as it is
associated with the hypothesis of the endogeneity of the optimum currency area
criteria, whereby a monetary union among member countries is predicted to
increase trade among them, which, in turn, may lead to more synchronized
business cycles. The empirical findings show that trade intensity among the
considered countries has indeed led to more synchronized business cycles,
suggesting that monetary union among EAC countries may be beneficial.
Moreover, the fourth and last paper uses a similarity index and a rank
correlation measure, Kendall’s tau, to investigate the movement of inflation rates
among EAC countries. The results show that changes in inflation have become
more similar over time and that there are high correlations between EAC
countries. This paper also investigates the convergence in inflation rate levels
among the EAC countries. It is found that these levels have tendency to converge.
These findings favor the formation of a monetary union among these countries.
