One Market, One Currency?

The economic desirability of a

monetary union for the CAN

CORREA Rafael

The Andean Community of Nations (Bolivia, Colombia, Ecuador, Peru and

Venezuela) will start in 2005 the Andean Common Market. However, the viability of a
deeper commercial integration seems to require the stabilization of the bilateral
exchange rates, not just to enhance the intra-regional trade but also because sharp
switches in the exchange rates can decrease the political support for a common
market.
Responding to this problem, this paper analyzes the economic desirability of a
common currency for the CAN countries. The basic theoretical framework for the
analysis is the Optimal Currency Area Theory (OCA) initiated by Mundell (1961).
Using the Gravity Model of trade, the study tests the existence of a commercial block
among the CAN countries and the role of the exchange rate volatility on the bilateral
trade. In addition, the study also evaluates the symmetry of shocks-responses
among the CAN countries, identifying supply and demand shocks using the
fundamental disturbances of vector autoregressive models.
The econometric analysis found no evidence of an actual Andean market and it
showed that the volatility of the bilateral exchange rates is impairing the intra-regional
trade. In this regard, a common currency would be highly desirable to secure the
success of the common market. The evidence also suggests that the heterogeneous
macroeconomic performance observed between the Andean countries is explained
not because idiosyncratic shocks, but rather because of the different size of
responses and speed of adjustment to common shocks. In turn, the presence of
common shocks is verifying the socio-economic similarity between the Andean
countries. Given this similarity of socio-economic structure, the differences of
responses and speed of adjustment represent a puzzle that could be explained by
institutional heterogeneity. In this regard, the cost of adopting a common currency
could decrease greatly after an adequate process of institutional harmonization.

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