Currency board
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A currency board is a monetary authority which is required to maintain a fixed exchange rate with a foreign currency. This policy objective requires the conventional objectives of a central bank to be subordinated to the exchange rate target.
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Features of "orthodox" currency boards
The main qualities of an orthodox currency board are:
- A currency board's foreign currency reserves must be sufficient to ensure that all holders of its notes and coins (and all banks creditor of a Reserve Account at the currency board) can convert them into the reserve currency (usually 110–115% of the monetary base M0).
- A currency board maintains absolute, unlimited convertibility between its notes and coins and the currency against which they are pegged (the anchor currency), at a fixed rate of exchange, with no restrictions on current-account or capital-account transactions.
- A currency board only earns profit from interests on foreign reserves (less the expense of note-issuing), and does not engage in forward-exchange transactions. These foreign reserves exist (1) because local notes have been issued in exchange, or (2) because commercial banks must by regulation deposit a minimum reserve at the Currency Board. (1) generates a seignorage revenue. (2) is the revenue on minimum reserves (revenue of investment activities less cost of minimum reserves remuneration)
- A currency board has no discretionary powers to effect monetary policy and does not lend to the government. Governments cannot print money, and can only tax or borrow to meet their spending commitments.
- A currency board does not act as a lender of last resort to commercial banks, and does not regulate reserve requirements.
- A currency board does not attempt to manipulate interest rates by establishing a discount rate like a central bank. The peg with the foreign currency tends to keep interest rates and inflation very closely aligned to those in the country against whose currency the peg is fixed.
Consequences of adopting a fixed exchange rate as prime target
The currency board in question will no longer issue fiat money but instead will only issue one unit of local currency for each unit (or decided amount) of foreign currency it has in its vault (often a hard currency such as the U.S. dollar or the euro). The surplus on the balance of payments of that country is reflected by higher deposits local banks hold at the central bank as well as (initially) higher deposits of the (net) exporting firms at their local banks. The growth of the domestic money supply can now be coupled to the additional deposits of the banks at the central bank that equals additional hard foreign exchange reserves in the hands of the central bank.
Pros and cons
The virtue of this system is that questions of currency stability no longer apply. The drawbacks are that the country no longer has the ability to set monetary policy according to other domestic considerations, and that the fixed exchange rate will, to a large extent, also fix a country's terms of trade, irrespective of economic differences between it and its trading partners. Typically, currency boards have advantages for small, open economies which would find independent monetary policy difficult to sustain. They can also form a credible commitment to low inflation.
Examples in recent history
Hong Kong operates a currency board (Hong Kong Monetary Authority), as do Bulgaria and Lithuania. Estonia established a currency board pegged to the Deutsche Mark in 1992 after gaining independence, and this policy is seen as a mainstay of that country's subsequent economic success (see Economy of Estonia for a detailed description of the Estonian currency board). Argentina abandoned its currency board in January 2002 after a severe recession. To some, this emphasised the fact that currency boards are not irrevocable, and hence may be abandoned in the face of speculation by foreign exchange traders. However, Argentina's system was not an orthodox currency board, as it did not strictly follow currency board rules - a fact which many see as the true cause of its collapse. Others argue that Argentina's monetary system was an inconsistent mixture of currency board and central banking elements. They think misunderstanding of the workings of the system by economists and policymakers contributed to the Argentine government's decision to devalue the peso in January 2002. The economy fell deeper into depression before a recovery began later in the year.
The British Overseas Territories of Gibraltar, the Falkland Islands and St. Helena continue to operate currency boards, backing their locally printed currency notes with pound sterling reserves.
A gold standard is a special case of a currency board where the value of the national currency is linked to the value of gold instead of a foreign currency.
Examples against the Euro
- Bulgarian lev
- Estonian kroon
- Bosnia and Herzegovina convertible mark (Konvertibilna marka)
- Lithuanian litas
- For complete listing, see currencies related to the euro
Examples against the U.S. dollar
- Hong Kong dollar
- Bermudian dollar
- Cayman Islands dollar
- Djiboutian franc
- East Caribbean dollar (Antigua and Barbuda, Dominica, Grenada, Saint Kitts and Nevis, Saint Lucia, and Saint Vincent and the Grenadines)
- For complete listing, see United States dollar
Examples against the pound sterling
Examples against other currencies
- Brunei dollar, against the Singapore dollar
- Macanese pataca, against the Hong Kong dollar
- The Faeroe Islands have a de jure currency board, but in fact the Danish National Bank serves as the lender of last resort and all bank accounts are denominated in Danish kroner. The Danish National Bank refers to the Faroese króna as a "special version" of the Danish krone.
Historical examples
- Irish pound, pegged against pound sterling from independence until 1979.
- Argentine peso, pegged against the United States dollar until 2002.
See also
References
Further reading
- Tiwari, Rajnish (2003): Post-Crisis Exchange Rate Regimes in Southeast Asia, Seminar Paper, University of Hamburg. (PDF)
For a precise definition of what constitutes a currency board, including past examples, see:
- Hanke, Steve H. (2002): On Dollarization and Currency Boards: Error and Deception, Journal of Policy Reform Vol. 5 no. 4, pp203-222. (PDF)
- Nikolay Nenovsky's works on Currency boards issues: (nikolaynenovsky.com )
External links
- Currency boards and dollarization
- Basics on currency boards on erols.com
- currency boards on erols.com
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