Is East Africa an Optimum Currency Area?

Abstract

The paper investigates whether the East African Community, comprising of Kenya, Tanzania, and Uganda, constitutes an optimum currency area or not. The East African Community has been revived, and one of the long-term objectives of the Community is to have a common currency. The paper employs the Generalised Purchasing Power Parity method, and various criteria suggested by the theory of Optimum Currency Areas to investigate the optimality of the Community as a currency area. While the various indices that we calculated based on the theory of Optimum Currency Areas gave mixed verdicts, the Generalised Purchasing Power Parity (G-PPP) method supports the formation of a currency union in the region. Using the G-PPP method, we were able to establish cointegration between the real exchange rates in East Africa for the period 1981 to 1998, and even for the period 1990 to 1998. This finding suggests that the three countries tend to be affected by similar shocks.