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Regional Monetary Arrangements for Developing Countries

November 1, 2000

The last decade witnessed a marked rise in regionalism across the developing world. Trade coalitions such as Mercosur became the subject of lively debate in academia and policy circles. And the World Trade Organization has estimated that, by the beginning of the millennium, virtually every developing country had joined some regional commercial agreement.

At the same time, several countries were successively hit by crises that devastated their financial systems and forced drastic changes in the exchange rate arrangements. In particular, the existence of a close link between financial crises and the collapse of currency pegs has convinced many that attempting to fix exchange rates is futile.

These two parallel developments have motivated the review of existing monetary institutions and the search for new and creative arrangements that may lead to improved stability and faster growth. So far, the debate has emphasized the choice between two alternatives: an irrevocably fixed exchange rate, as implemented by Argentina’s currency board, or, more extremely, unilateral dollarization as in Ecuador and El Salvador; and a regime of flexible exchange rates, as chosen by Mexico or Peru. But, while these two positions would seem polar extremes, they have something important in common: they are unilateral arrangements whose implementation would be independent of multilateral agreements of any kind.

In this paper we shall examine a third alternative: to create some form of a regional monetary arrangement. This possibility has been mentioned in East Asia as a way to cope with its recent financial instability; likewise, the idea of a common currency for Mercosur countries has been advanced to further trade and growth in the Southern Cone. An urgent issue facing developing countries is, therefore, to decide whether and to what extent regional monetary integration may be possible or beneficial. This paper attempts to shed light on this topic.

Section 2 reviews different kinds of monetary arrangements, with special reference to existing agreements such as the CFA zone and the Latin American Reserve Fund. One lesson from the discussion is that, for a regional agreement to make a substantial difference, it may need to evolve towards its extreme incarnation, a monetary union with a common currency. Consequently, the rest of the paper is devoted to a deeper discussion of the costs and benefits of regional monetary unions. The costs are discussed in section 3, and the benefits in section 4. Section 5 discusses the feasibility of regional monetary unions, emphasizing the potential conflicts of interest that may emerge between prospective members. Finally, Section 6 concludes with a summary and some conclusions for policy.

By Roberto Chang

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