Fiscal Reform and Monetary Union in West Africa

where country i knows that central bank j will not react to developments in economy i.
Given that this is a unilateral peg, π_j= π_i. But not only is the rate of inflation exogenous,
so is seigniorage. Although it would be possible with a currency board to deposit currency
reserves with the issuing central bank and thus earn some (modest) seigniorage, these
revenues would necessarily be zero in case of an introduction of a foreign currency.¹¹ In that
case, such a unilateral peg would imply less seigniorage than with the own currency. I
therefore present the effects of the two forms of fixed exchange rates separately.

With the unilateral peg (indexed P), the government in country i will its set structural
reform efforts as

si^P

^c [Fj ^{+ b} (У* ^- ʃɔj
λb² + c²

(19)

and its fiscal policy will be

^xi^P

λbFj - c² (y* - y_i) - d n ∑j [< ⁺ fe^- y₁ ^)]
λb² + c²                bθB

(20)

The last term in (20) captures the seigniorage gain for country i. There are j member
in the monetary union whose average distortions in output and fiscal policy determine the
inflation rate set by the common central bank.

With the one-sided peg, the government's structural reform efforts would not change
in comparison to a unilateral peg. It would be given as expressed in (19). Its fiscal policy,

¹¹ In fact the opposite is true. The anchor currency would, with full dollarization, be
able to increase its seigniorage revenue. I abstract from this here, assuming that this does
not enter the calculation of the anchor country. See Calvo (1999) on possibilities to share
seigniorage revenue.

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