This study seeks to investigate the viability of EAC countries to form common currency by testing where countries constitute optimal currency area (OCA). Also the study examines the role of three transmission channels (credit, money and exchange rate) on monetary transmission mechanism in EAC countries from 1995 to 2016. These are important things to consider in order to have successful regional monetary union, and in order to conduct successful monetary policy under monetary union it is important to understand the role of transmission mechanism channels in the monetary transmission mechanism.
The stud employs Johansen technique to estimate the Generalised Purchasing Power Parity (G –
PPP) to test for optimality of EAC to form single currency. Panel data approach employed to
assess the role of three transmission channels (credit, money and exchange rate) on monetary transmission mechanism to EAC countries. The study use secondary data with cross section of five countries and time series of twenty one years that obtained from Word Bank.
The first result that based on G – PPP and Johansen technique show that there is existence of
existence co integration relationship among EAC countries this means that so far the regional is
viable for monetary union and forming single currency. However there still existing a difference behaviour between the real exchange rates among EAC member states we suggest that before establishing or introducing single currency they would be desirable for example to introduce the system like European ERM (Exchange Rate Mechanism) which introduce 1999 in a preparation for economic and monetary union and introducing single currency. By introducing this system it will help to reduce differences on EAC countries exchange rates and it will improve monetary policy coordination among EAC countries. The result of panel data shows that money supply channel has positive and significant effect to the real economy hence it play important role in transmission of monetary policy in EAC countries. Remain channels (credit and exchange rate are not significant in transmission mechanism thus may not be important in transmission monetary policy to EAC countries.
Despite the result we found that show suitability for single currency to EAC countries the study suggest the consideration of other fact such as political factor (political will and support), degree and financial integration and mobility factor, which are essential fact to consider in order to have successful monetary union.
Key words: Monetary Union; Monetary Transmission Mechanism; Monetary Policy; Optimal
Currency Area (OCA), East Africa Community (EAC)
