Benefits from Mutual Restraint in a Multilateral Monetary Union

We show that monetary union can enhance price stability for its member countries even if none of them has a long history of stable prices and independent monetary policy, as is the case in a number of monetary union initiatives among developing countries. The positive effect obtains because the opportunistic objectives of one country's policy makers are kept in check at the union level by other members with disparate objectives. We calibrate the model to evaluate the proposed monetary union in the East African Community. The empirical results show that the mutual restraint on monetary policy is an important determinant of the expected benefit from an EAC monetary union. (C) 2008 Elsevier Ltd. All rights reserved.