Fiscal Reform and Monetary Union in West Africa

less distortive than under full monetary union. Therefore, structural reform efforts will also
be higher in this case than with full monetary union.

Proof: See the Appendix.

Because there is no influence of fiscal policy on inflation in this case, there is a
reduced incentive to implement these reforms. In addition, there is no seigniorage revenue
at all. Lower revenue would seem to imply that there will be more structural reforms but
this is not the case. Compared to monetary autonomy, this is because although it lowers
output, the constraint from inflation aversion is improved. Thus, fiscal policy can become
more distortive without any inflationary reaction. Given that inflation does not react to xi,
the budget constraint is not altered, and more fiscal revenues mean automatically less fiscal
reforms. Therefore, the unilateral adoption of a foreign currency is only advisable for
countries that assign a high value to keeping inflation low. They will have to pay for zero
inflation with lower output and less structural reforms.

This is different, however, when compared to the case of full membership in a
symmetric monetary union. Fiscal policy would be more distortive under monetary union
because the government anticipates the central bank's reaction. This is not the case here,
hence fiscal policy must not become too expansive in order to keep unemployment low.
Therefore, the unilateral adoption is preferable to full monetary union for output. Also,
there will be more structural reforms in this case than with full monetary union. There is
hence a change in the optimal behavior of the government. The non-reaction of inflation to
fiscal policy is an incentive to implement a more distortive policy. But this negative
reaction will be less strong than with monetary union. At some point, the aversion to output
falls becomes dominant.

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