Economics
Currency Board
A currency board is a monetary system that maintains a fixed exchange rate with a foreign currency by holding reserves in that currency. It issues domestic currency fully backed by foreign reserves, ensuring stability and credibility in the monetary system. This system limits the ability of the central bank to conduct independent monetary policy, as it must maintain the fixed exchange rate.
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11 Key excerpts on "Currency Board"
- Richard J Sweeney(Author)
- 2019(Publication Date)
- Taylor & Francis(Publisher)
Historically, the record is not encouraging: until the 1980s and 1990s, no Currency Board has lasted very long nor has any of their pegged rates. Indeed, some say that "permanently fixed exchange rates" is an oxymoron. The fact that the country maintaining the peg must often take action to protect the peg's value means that there may come a day when the game appears not worth the candle, and the "permanent" peg is changed. A Currency Board is one among many mechanisms for running a fixed exchange rate. The most fervent Currency Board advocates recognize that there are either formal, de jure escape hatchs that allow changes, or informal, de facto ways that allow changes (peg changes are historically accompanied or preceded by changes from a Currency Board to some other form of exchange rate management, usually a central bank). Most Currency Board advocates view the establishment of a nominal anchor as the board's main contribution. The rules that govern a Currency Board impose monetary and, perhaps to a lesser, indirect extent, fiscal discipline, and keep the country from inflating as much as it otherwise would. To the extent the Currency Board succeeds, it spares the country the costs of high and erratic inflation. 1 Further, establishing a (strong) Currency Board may help lend credibility to the government's commitment to fight inflation; a credible commitment to an anti-inflation policy reduces inflation more quickly, and at lower cost, than a commitment that proves itself only gradually and incurs the cost of output losses and excess unemployment. In addition, many Currency Board advocates envision the board as operating in the context of free-market international trade and no or relatively minor capital controls. By contributing to financial and monetary stability, the board helps the economy reap the benefits of international openness, benefits less available to countries with substantially less discipline
- Kai Stukenbrock(Author)
- 2018(Publication Date)
- Peter Lang International Academic Publishers(Publisher)
Chapter 2 Currency Boards-An Overview This chapter is intended to give a very brief overview over Currency Board design and characteristics. Section 2.1 explains the basic design features of Currency Boards and what distinguishes them from central banks. Section 2.2 then shortly examines the pros and cons as well as prerequisites for suc-cessfully operating a Currency Board. 2.1 Basic Features of a Currency Board 2.1.1 Definition of a Currency Board A Currency Board (CB) is a very simple, strictly rule-bound institution for supplying an economy with a domestic currency. In the past, Currency Boards have usually been operating in place of a central bank, although more recent Currency Boards, starting with Argentina 1991, have usually been set up within previously existing central banks. A typical Currency Board is defined by the four following central features: Fixed exchange rate The value of the domestic currency is strictly tied to the value of an anchor currency at a fixed rate of exchange. Until the second half of the 20th century, the predominant anchor currency was the British pound sterling, although there have been pegs to other currencies and even gold, as well. Recent Currency Boards have either chosen the US dollar or the Deutsche mark, respectively the euro since the introduction of the common European currency, as an anchor. Kai Stukenbrock - 978-3-631-75699-7 Downloaded from PubFactory at 01/11/2019 02:47:34AM via free access 30 2. Currency BoardS-AN OVERVIEW Backing requirement A typical Currency Board is required to fully back the monetary base with foreign exchange reserves. Foreign exchange reserves held by the board must at all times be sufficient to, at least theoretically, convert all notes and coins in circulation, as well as all domestic currency deposits held with the Currency Board, into the anchor currency at the fixed exchange rate. Domestic currency can only be issued in exchange for the respective amount of foreign exchange.
eBook - PDFTrade, Development, and Political Economy in East Asia
Essays in Honour of Hal Hill
- Prema-Chandra Athukorala, Arianto Patunru(Authors)
- 2014(Publication Date)
- ISEAS Publishing(Publisher)
In particular, a Currency Board does not lend to either the government or the private sector. A central feature of the system is that the board stands ready to con-vert the local currency it has issued to a particular foreign currency (such as the US dollar) at a permanently fixed rate of exchange. Moreover, it is required to maintain a level of foreign exchange reserves at least equal to the value of its base money liabilities (when converted at this fixed rate). Here lies a key difference from central banks: the latter may promise to hold their exchange rate fixed, but they do not always maintain sufficient reserves to be able to keep that promise. Thailand in 1997 is an example of this. Unlike a central bank, a Currency Board cannot run out of foreign exchange reserves: the private sector (including the commercial banks) will necessarily run out of the base money it needs in order to purchase foreign exchange from the board before the board runs out of foreign exchange. Misunderstanding of this fundamental point is widespread. For example, an editorial in the highly respected Financial Times on 12 Febru-ary 1998 argued—entirely incorrectly—that: Optimists blithely assume a Currency Board would be protected from spec-ulative attack because the central bank’s $19bn hard currency reserves are triple the value of rupiah notes and coins at current exchange rates. This is nonsense. Notes and coins are only a tiny fraction of the total money sup-ply. Moreover, the reserves are swamped by the country’s US$137bn foreign debt—much of it short term and owed by private companies. The crucial point that this writer and others at the time and later (e.g. Lakshmanan 1998; Singal 1999, 55) failed to understand was that the major part of the broad money supply—bank deposits—cannot be used directly to purchase foreign exchange from the Currency Board, only base money (that is, currency in circulation and deposits of the commercial banks at the Currency Board).
eBook - ePubReclaiming Development
An Alternative Economic Policy Manual
- Ha-Joon Chang, Ilene Grabel(Authors)
- 2014(Publication Date)
- Zed Books(Publisher)
Full currency substitution involves legally replacing the domestic currency with a strong foreign currency. This strategy is sometimes referred to as dollarization, since the US dollar is the currency most commonly employed in full currency substitution arrangements.In other words, only ‘extreme’ exchange rate systems (termed ‘corner solutions’ in the academic literature) are workable. On one end of the exchange rate continuum is the ideal of floating rates; on the other end are second-best systems of extreme exchange rate fixity embodied in Currency Boards or currency substitution. Exchange rate regimes that fall between the extremes of floating and extreme fixity (termed ‘intermediate regimes’ – fairly wide currency pegs or crawling-peg regimes) are destined to fail.2Some countries need the discipline and credibility associated with Currency Boards.Currency Boards have several desirable features. They maintain exchange rate stability and thereby prevent currency crises. They prevent high inflation by setting strict conditions on the circumstances under which the domestic money supply can be increased. And, finally, Currency Boards promote foreign investment and confidence by resolving problems of currency and price volatility and by delegating policy to an institution that divests corrupt or inept politicians from any influence over the national currency (see also Chapter 6 and section 11.2 below for similar arguments on behalf of independent central banks).Today, Currency Boards operate in Bermuda, Bulgaria, Bosnia and Herzegovina, Cayman Islands, Djibouti, Estonia, Falkland Islands, Faroe Islands, Gibraltar, Hong Kong and Lithuania. For some countries, even Currency Boards do not offer sufficient discipline and credibility. In these cases, full currency substitution is necessary.Full currency substitution is preferable to a Currency Board whenever the government cannot be trusted to respect the operational independence of the Currency Board or whenever policymakers seek the most rapid route to exchange rate stability and international credibility. As of 2001, twenty-three countries maintain full currency substitution, while fourteen countries maintain partial currency substitution. Countries that maintain full currency substitution include Ecuador, El Salvador, Panama, Northern Cyprus, and the British Virgin Islands; countries that maintain partial currency substitution include Cambodia, Liberia, Guatemala, Namibia and Tajikistan. Partial substitution refers to circumstances wherein the national currency circulates alongside a much more widely utilized foreign currency.
- Jutta Maute(Author)
- 2018(Publication Date)
- Peter Lang International Academic Publishers(Publisher)
As a Currency Board does not engage in accommodating treasury bill markets, short-term fluctuations in treasury cash flows may occur and create additional stress for public finances 288 . In the worst case, where governments cease to accept their financial subordination to the monetary regime, there is a possibility that they might raid the Currency Board in one form or another, e.g. by demonetising the Currency Board currency and issuing an own parallel currency. Therefore, although a Currency Board is able to reinforce an existing political commitment to fiscal discipline, it is jeopardised when such commitment is fading 289 . 3.2.3 Considerations for Adopting a Currency Board 3.2.3.1 When is a Currency Board an Appropriate Choice? As Fuhrmann (1999) notes, there is no theory that would predict under which circumstances and preconditions the introduction of a Currency Board is an optimal strategy 290 . In this context, most economists refer to a number of criteria that stem from the theory of optimal currency areas, supplemented by some arguments that take account of the special application of a Currency Board as a stabilisation vehicle. (1) Only small and open economies benefit from an external nominal anchor. For an open economy (i.e. one with a high proportion of imports and exports to GDP), exchange rate uncertainty induces greater costs than for a closed economy, and fixing the exchange rate will to a greater extent imply a fixing of the price level. Since small economies tend to be more open, both criteria are intertwined 291 . Therefore, the argument holds, for small economies with the typical low degree of diversification, the best strategy is to choose fixed exchange rates in order to adapt to international price structures and maximise the advantages that arise from the 288 See Baliiio/Enoch (1997), p. 18. 289 See Williamson (1995), pp. 28-9. 290 See Fuhrmann (1999), p.
eBook - ePubRussian Currency and Finance
A Currency Board Approach to Reform
- Steve H. Hanke, Lars Jonung, Kurt Schuler(Authors)
- 2005(Publication Date)
- Routledge(Publisher)
Furthermore, the rate the Estonian government used for converting roubles into kroons was questionable. Our earlier book mainly explained how the kroon could be introduced as a parallel currency, but it also explained how to conduct a currency conversion, as Estonia did. For the case of a currency conversion, the book emphasized the importance of using unrestricted exchange rates as a guide for setting a fixed exchange rate with a reserve currency. Before Estonia’s monetary reform, Estonia had Soviet-style controls on foreign exchange, not an unrestricted foreign–exchange market. The interbank exchange rate of the rouble at the time reflected even more extensive foreign-exchange controls than those that exist today for the rouble. The exchange rate of 10 roubles per kroon used in the monetary reform made Estonian wages and the prices of traded goods grossly undervalued compared to wages and prices in Germany. Consequently, Estonia has had much higher inflation than Germany since the reform as Estonian wages and prices catch up to market-clearing levels (FBIS 1992r, t). The catch-up period may create political pressure for continuing inflation if wage and price increases achieve such momentum that they temporarily overshoot market-clearing levels, causing the real exchange rate to become overvalued; the Estonian government may respond by devaluing the kroon.We wish success for the present Argentine and Estonian monetary systems. We think, however, that their prospects for success in the long run would be enhanced if they became orthodox Currency Board systems.Other Cases
Besides the monetary systems of Argentina and Estonia, some other monetary systems have also mistakenly been classified as Currency Board systems. Among them are the monetary systems of Singapore and Brunei. (We ourselves have in the past called Singapore and Brunei unorthodox or modified Currency Board systems.) The monetary authorities of Singapore and Brunei hold 100 per cent foreign reserves against the monetary base, but hold a basket of currencies rather than a single currency and have maintained no fixed exchange rate with a reserve currency since 1973. In practice, the Singapore and Brunei dollars appreciate gradually against the US dollar (Lee 1986: 85-91, 150-65). Therefore, despite the historical roots of the present Singapore and Brunei systems in the Currency Board system, and despite the existence of a body called the Singapore Currency Board (which is in effect the note-issuing branch of the Monetary Authority of Singapore), it seems best to classify them as central banking systems that mimic the 100 per cent foreign reserve feature of the Currency Board system.Other central banking systems sometimes mistaken for Currency Board systems hold 100 per cent reserves only against some liabilities.59 A central bank required to hold 100 per cent foreign reserves against notes and coins in circulation, but not against deposits, is not a Currency Board. To illustrate the difference, compare Figures 4.5 and 4.6
- Charles Enoch, and Tomás Baliño(Authors)
- 1997(Publication Date)
- INTERNATIONAL MONETARY FUND(Publisher)
II. Considerations for Adopting a Currency Board
CBAs may appear attractive to small open economies with limited central banking expertise and incipient financial markets, or to countries that wish to preserve the benefits of belonging to a broader trade or currency area, or envisage joining a currency union. In addition, they may be attractive to countries where lack of credibility severely constrains the effectiveness of monetary policy or exposes the economy to recurrent currency crises and high risk premiums (Box 3 ). However, a CBA cannot of itself create credibility unless accompanied by firm supporting policies. Without such policies, credibility will remain low, which will undermine the sustainability of the CBA itself.
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Strengths of a Currency Board Arrangement
A CBA’s strength accrues from its simplicity and the limited discretion of its operating rules. These rules eliminate or sharply limit the scope for discretion in monetary and foreign exchange rate policies, and thereby enhance the credibility of conventional fixed pegs and simplify central bank operations. They can be particularly helpful in cases where despite a strong commitment to financial discipline the political process is unlikely to give the central bank a high degree of independence or the central bank has not as yet been unable to establish a solid track record.Administrative and Operational Simplicity
The extreme simplicity and transparency of a CBA is appealing. Its operating rules are easily understood and monitored by the general public, if appropriate information is provided. Pegging the exchange rate simplifies the operation and monitoring of the foreign exchange market. Streamlining monetary operations and delegating other central bank functions, such as payments system and fiscal agent functions, can sharply reduce the need for staff and bookkeeping.
- East Asian Institute(Author)
- 1998(Publication Date)
- WSPC(Publisher)
While this subject is beyond the scope of this paper, both economists and policy-makers should begin to think hard about the long-term implications of the present monetary regime and its possible modifications. For the time being, the evidence is overwhelming that the second Currency Board had played the role of a guardian angel for Hong Kong during one of the most critical periods of its history. At the same time, Hong Kong's unique historical circumstances also explain much why its monetary system has become what it is today. It would be both unrealistic and presumptuous therefore to say that Hong Kong's experience can be unconditionally emulated and transplanted elsewhere. One need not be, in Williamson's words, a monetary evangelical to appreciate the importance of the Currency Board for Hong Kong. Hong Kong's Monetary System 67 References Bennett, A.G.G. (1993) The Operation of the Estonian Currency Board, IMF Staff Papers, 40, 451-470. Camard, W. (1996) Discretion with Rules? Lessons from the Currency Board Arrangement in Lithuania, IMF Papers on Policy Analysis and Assessment, 96/1. Chan, B.S.S. (1997) Choosing an Exchange Rate Regime for a Sub-national Economy: An Optimum Currency Area Perspective, unpublished Ph.D. thesis, University of Hong Kong. Chen, Y. (1996) Monetary Relations between China and Hong Kong, paper presented to the Bank of England Seminar on Hong Kong's Monetary Arrangements through 1997 (Hong Kong: Hong Kong Monetary Authority). Clauson, G.L.M. (1994) The British Colonial Currency System, Economic Journal, LIV, 1-25. Fieleke, N.S. (1992) The Quest for Sound Money: Currency Board to the Rescue?, New England Economic Review, Nov./Dec, 14-25. Freris, A.F. (1991) The Exchange Fund and Monetary Policy, in Y.C. Jao (ed.), Monetary Management in Hong Kong (Hong Kong: The Chartered Institute of Bankers), 2-24. Greaves, I. (1953) Colonial Monetary Conditions. London: HMSO.
eBook - PDF- Carol Wise, Riordan Roett, Carol Wise, Riordan Roett(Authors)
- 2011(Publication Date)
- Brookings Institution Press(Publisher)
When the disturbances impinging on an econ-omy are predominantly monetary, an anchored exchange rate that fixes the currency to that of another country with a history of low inflation may be the only way to establish the necessary credibility. This was precisely the situation in which Argentina found itself when the government launched the Convertibility Plan in April 1991. When monthly rates of inflation suddenly burst from the 20 to 30 percent range in the late 1980s to 90 to 200 percent in 1989-90, the administration of President Carlos Menem had little choice but to pursue one of the most credibility-enhancing strategies available to a country in the throes of hyperinflation: a Currency Board. 4 Under the Currency Board, the Argentine peso was fixed one-to-one to the U.S. dollar, and full convertibility was established between the two currencies. At the same time, the discretionary lending powers of the Argentine central bank were sharply curtailed, and the bank was required to maintain foreign reserves totaling 100 percent of the domestic monetary base. The Convertibility Plan effectively tied the hands of domestic policymakers, as the Currency Board shifted the burden of responsibility for monetary policy and, to a lesser extent, fiscal restraint onto the external sector. This minimal room to maneuver has fueled other arguments about the need for greater exchange rate flexibility. The trend toward greater flexi-bility has been associated with more open, outward-oriented trade and ARGENTINA'S Currency Board 95 investment policies across the developing world, as well as with high lev-els of international capital mobility in the 1990s. The success of the Argentine strategy in reducing inflation and restoring macroeconomic stability in the face of increased international volatility is indisputable.
eBook - PDFHong Kong SAR Monetary and Exchange Rate Challenges
Historical Perspectives
- C. Schenk(Author)
- 2008(Publication Date)
- Palgrave Macmillan(Publisher)
There was a natural tendency for the exchange rate between the local currency and the anchor currency to hold close to the fixed rate which had been set for notes and coin. In other words, the whole economy was seen to function at that fixed rate. Until the time came when a colony began to talk about monetary independence and establishing its own central bank, there was scarcely the slightest doubt that the colony’s currency would remain at its fixed rate. Because the Currency Board, as practised today in Hong Kong and a few other places, is somewhat different from the simple colonial Tony Latter 97 version – most notably because the monetary base to which the con- vertibility rules apply now includes the reserve money of the banking system – there is some confusion as to what constitutes the strict or pure model. In fact, there is no unequivocal definition. One might be inclined to take an entry in Palgrave as authoritative, but even there Alan Walters, after noting the initial colonial cash-only model, tended to sidestep the matter of the current definition. 7 Where do the definitional uncertainties arise? It may be sufficient to provide four examples. (a) First, under the simple sterling-based arrangements referred to above, the question of the convertibility of banks’ reserve money balances did not arise, essentially because the financial systems had not yet reached that stage of development. The Currency Board was based only on physical currency; it was not involved in interbank settlement; the metropolitan authorities were effectively in charge of wider monetary and economic issues. That leaves one in a quan- dary as to whether the ‘pure’ model should only embrace cash, or whether, because cash was in the early days equal to monetary base, and because monetary base now includes banks’ balances, a Currency Board must necessarily adopt the wider coverage.
No longer available |Learn more- United Nations Economic and Social Commission for Asia and the Pacific(Author)
- 1947(Publication Date)
- United Nations Publications(Publisher)
The issue which will continue to be on the basis of rigid convertibility with sterling, will remain in the hands of the exist-ing Currency Board which may almost be described as a branch of the Treasury. But that in general the establishment of central banks implies an assault on the prevailing exchange standards, can hardly be doubted. The introduction of trade and exchange controls has, of course, already modified the rigidity of exchange standards to an appreciable extent, but quite apart from that, the trend seems to be to replace exchange standards by managed currency systems. Needless to say, the movement has been possible largely as the result of greater political freedom of the countries concerned. Political dependency almost automatically meant exchange standards. With larger political powers, it is now possible for these countries to free their currencies from rigid links with the Metropolitan currencies. The departure also therefore signals a weakening of existing currency areas, such as the Sterling Area and the French Monetary Area. 3. There has been a movement towards (a) greater control and co-ordination of credit, and (b) unification of currency and credit admi-nistration. This movement is not quite the same as the movement for the adoption of managed currencies. It is more specifically a movement for central banks, with or without managed currencies. A central bank can of course be created with full powers to manage the supply of money, but it can also be created for the more modest object of (a) guid-ing, assisting and controlling the other banks, and (b) issuing notes according to rigidly laid down rules. Hitherto, in most ECAFE coun-tries, banking has been uncontrolled and decentralized and note issue has been in the hands of the government. This lack of control over credit and divorce between currency and credit is now sought to be remedied by establishing new central banks or by giving greater powers to the existing ones.
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