Currency board
Overview
 
A currency board is a monetary authority
Monetary authority
Monetary authority is a generic term in finance and economics for the entity which controls the money supply of a given currency, and has the right to set interest rates, and other parameters which control the cost and availability of money...

 which is required to maintain a fixed exchange rate
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...

 with a foreign currency. This policy objective requires the conventional objectives of a central bank to be subordinated to the exchange rate target.
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
    Monetary base
    In economics, the monetary base is a term relating to the money supply , the amount of money in the economy...

     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.
Encyclopedia
A currency board is a monetary authority
Monetary authority
Monetary authority is a generic term in finance and economics for the entity which controls the money supply of a given currency, and has the right to set interest rates, and other parameters which control the cost and availability of money...

 which is required to maintain a fixed exchange rate
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...

 with a foreign currency. This policy objective requires the conventional objectives of a central bank to be subordinated to the exchange rate target.

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
    Monetary base
    In economics, the monetary base is a term relating to the money supply , the amount of money in the economy...

     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
    Reserve requirement
    The reserve requirement is a central bank regulation that sets the minimum reserves each commercial bank must hold of customer deposits and notes...

     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 affect monetary policy
    Monetary policy
    Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

     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
    Lender of last resort
    A lender of last resort is an institution willing to extend credit when no one else will. The term refers especially to a reserve financial institution, most often the central bank of a country, intended to avoid bankruptcy of banks or other institutions deemed systemically important or 'too big to...

     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
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...

 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
Hard currency
Hard currency , in economics, refers to a globally traded currency that is expected to serve as a reliable and stable store of value...

 such as the U.S. dollar
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....

 or the euro
Euro
The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...

). The surplus on the balance of payments
Balance of payments
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...

 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
Foreign exchange reserves
Foreign-exchange reserves in a strict sense are 'only' the foreign currency deposits and bonds held by central banks and monetary authorities. However, the term in popular usage commonly includes foreign exchange and gold, Special Drawing Rights and International Monetary Fund reserve positions...

 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
Hong Kong
Hong Kong is one of two Special Administrative Regions of the People's Republic of China , the other being Macau. A city-state situated on China's south coast and enclosed by the Pearl River Delta and South China Sea, it is renowned for its expansive skyline and deep natural harbour...

 operates a currency board (Hong Kong Monetary Authority
Hong Kong Monetary Authority
The Hong Kong Monetary Authority or HKMA is Hong Kong's central banking institution . It is a government authority founded on 1 April 1993 via the consolidation of "Office of the Exchange Fund" and the "Office of the Commissioner of Banking"...

), as do Bulgaria
Bulgaria
Bulgaria , officially the Republic of Bulgaria , is a parliamentary democracy within a unitary constitutional republic in Southeast Europe. The country borders Romania to the north, Serbia and Macedonia to the west, Greece and Turkey to the south, as well as the Black Sea to the east...

 and Lithuania
Lithuania
Lithuania , officially the Republic of Lithuania is a country in Northern Europe, the biggest of the three Baltic states. It is situated along the southeastern shore of the Baltic Sea, whereby to the west lie Sweden and Denmark...

. Estonia
Estonia
Estonia , officially the Republic of Estonia , is a state in the Baltic region of Northern Europe. It is bordered to the north by the Gulf of Finland, to the west by the Baltic Sea, to the south by Latvia , and to the east by Lake Peipsi and the Russian Federation . Across the Baltic Sea lies...

 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
Economy of Estonia
Estonia is a member of the European Union and the eurozone and is an advanced economy, according to the IMF.Before the Second World War Estonia's economy was based on agriculture, but there was a significant knowledge sector and a growing industrial sector, similar to Finland...

 for a detailed description of the Estonian currency board). Argentina
Argentina
Argentina , officially the Argentine Republic , is the second largest country in South America by land area, after Brazil. It is constituted as a federation of 23 provinces and an autonomous city, Buenos Aires...

 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
British overseas territories
The British Overseas Territories are fourteen territories of the United Kingdom which, although they do not form part of the United Kingdom itself, fall under its jurisdiction. They are remnants of the British Empire that have not acquired independence or have voted to remain British territories...

 of Gibraltar
Gibraltar
Gibraltar is a British overseas territory located on the southern end of the Iberian Peninsula at the entrance of the Mediterranean. A peninsula with an area of , it has a northern border with Andalusia, Spain. The Rock of Gibraltar is the major landmark of the region...

, the Falkland Islands
Falkland Islands
The Falkland Islands are an archipelago in the South Atlantic Ocean, located about from the coast of mainland South America. The archipelago consists of East Falkland, West Falkland and 776 lesser islands. The capital, Stanley, is on East Falkland...

 and St. Helena continue to operate currency boards, backing their locally printed currency notes with pound sterling
Pound sterling
The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...

 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
    Bulgarian lev
    The lev is the currency of Bulgaria. It is divided in 100 stotinki . In archaic Bulgarian the word "lev" meant "lion".It is speculated that Bulgaria, as a member of the European Union will adopt the Euro in 2015 .- First lev, 1881–1952 :...

  • Estonian kroon
    Estonian kroon
    In 1992, coins were introduced in denominations of 5, 10, 20 & 50 senti, as well as 1 kroon. The 1 kroon was struck in cupronickel, the others in aluminum-bronze. However, in 1997, nickel-plated steel 20 senti were introduced, followed by aluminum-bronze 1 kroon in 1998. 5 senti coins were not...

  • Bosnia and Herzegovina convertible mark
    Bosnia and Herzegovina convertible mark
    The Bosnia and Herzegovina convertible mark is the currency of Bosnia and Herzegovina. It is divided into 100 fenings...

     (Konvertibilna marka)
  • Lithuanian litas
    Lithuanian litas
    The Lithuanian litas is the currency of Lithuania. It is divided into 100 centų...

  • Danish Krone
    Danish krone
    The krone is the official currency of the Kingdom of Denmark consisting of Denmark, the Faroe Islands and Greenland. It is subdivided into 100 øre...

    • For complete listing, see currencies related to the euro

Examples against the U.S. dollar

  • Hong Kong dollar
    Hong Kong dollar
    The Hong Kong dollar is the currency of the jurisdiction. It is the eighth most traded currency in the world. In English, it is normally abbreviated with the dollar sign $, or alternatively HK$ to distinguish it from other dollar-denominated currencies...

  • Bermudian dollar
  • Cayman Islands dollar
    Cayman Islands dollar
    The Cayman Islands Dollar is the currency of the Cayman Islands. It is abbreviated with the dollar sign $, or alternatively CI$ to distinguish it from other dollar-denominated currencies. It is subdivided into 100 cents...

  • Djiboutian franc
    Djiboutian franc
    The franc is the currency of Djibouti. The ISO 4217 currency code is DJF. Historically it was subdivided into 100 centimes.- History :...

  • East Caribbean dollar
    East Caribbean dollar
    The East Caribbean dollar is the currency of eight of the nine members of the Organisation of Eastern Caribbean States...

     (Antigua
    Antigua
    Antigua , also known as Waladli, is an island in the West Indies, in the Leeward Islands in the Caribbean region, the main island of the country of Antigua and Barbuda. Antigua means "ancient" in Spanish and was named by Christopher Columbus after an icon in Seville Cathedral, Santa Maria de la...

     and Barbuda
    Barbuda
    Barbuda is an island in the Eastern Caribbean, and forms part of the state of Antigua and Barbuda. It has a population of about 1,500, most of whom live in the town of Codrington.-Location:...

    , Dominica
    Dominica
    Dominica , officially the Commonwealth of Dominica, is an island nation in the Lesser Antilles region of the Caribbean Sea, south-southeast of Guadeloupe and northwest of Martinique. Its size is and the highest point in the country is Morne Diablotins, which has an elevation of . The Commonwealth...

    , Grenada
    Grenada
    Grenada is an island country and Commonwealth Realm consisting of the island of Grenada and six smaller islands at the southern end of the Grenadines in the southeastern Caribbean Sea...

    , Saint Kitts and Nevis
    Saint Kitts and Nevis
    The Federation of Saint Kitts and Nevis , located in the Leeward Islands, is a federal two-island nation in the West Indies. It is the smallest sovereign state in the Americas, in both area and population....

    , Saint Lucia
    Saint Lucia
    Saint Lucia is an island country in the eastern Caribbean Sea on the boundary with the Atlantic Ocean. Part of the Lesser Antilles, it is located north/northeast of the island of Saint Vincent, northwest of Barbados and south of Martinique. It covers a land area of 620 km2 and has an...

    , and Saint Vincent and the Grenadines
    Saint Vincent and the Grenadines
    Saint Vincent and the Grenadines is an island country in the Lesser Antilles chain, namely in the southern portion of the Windward Islands, which lie at the southern end of the eastern border of the Caribbean Sea where the latter meets the Atlantic Ocean....

    )
    • For complete listing, see United States dollar
      United States dollar
      The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....


Examples against the pound sterling

  • Falkland Islands pound
    Falkland Islands pound
    The pound is the currency of the Falkland Islands, a British Overseas Territory in the South Atlantic Ocean. The symbol is the pound sign, £, or alternatively FK£, to distinguish it from other pound-denominated currencies...

  • Gibraltar pound
    Gibraltar pound
    The Gibraltar pound is the currency of Gibraltar. It is exchangeable with the UK pound sterling at par value.-History:...

  • Saint Helena pound
    Saint Helena pound
    The Saint Helena pound is the currency of the Atlantic islands of Saint Helena and Ascension, which are constituents of the British overseas territory of Saint Helena, Ascension and Tristan da Cunha...


Examples against other currencies

  • Brunei dollar
    Brunei dollar
    The ringgit Brunei or the Brunei dollar , has been the currency of the Sultanate of Brunei since 1967...

    , against the Singapore dollar
    Singapore dollar
    The Singapore dollar or Dollar is the official currency of Singapore. It is normally abbreviated with the dollar sign $, or alternatively S$ to distinguish it from other dollar-denominated currencies...

  • Macanese pataca
    Macanese pataca
    The pataca is the currency of Macau. It is subdivided into 100 avos , with 10 avos called ho in Cantonese. The abbreviation MOP$ is commonly used....

    , against the Hong Kong dollar
    Hong Kong dollar
    The Hong Kong dollar is the currency of the jurisdiction. It is the eighth most traded currency in the world. In English, it is normally abbreviated with the dollar sign $, or alternatively HK$ to distinguish it from other dollar-denominated currencies...

  • 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 krone
    Danish krone
    The krone is the official currency of the Kingdom of Denmark consisting of Denmark, the Faroe Islands and Greenland. It is subdivided into 100 øre...

    r. The Danish National Bank refers to the Faroese króna
    Faroese króna
    The króna is the currency of the Faroe Islands. It is issued by the Danish National Bank. It is not an independent currency but a version of the Danish krone. Consequently, it does not have an ISO 4217 currency code. The ISO 4217 code for the Danish krone is DKK...

     as a "special version" of the Danish krone. Danish krone
    Danish krone
    The krone is the official currency of the Kingdom of Denmark consisting of Denmark, the Faroe Islands and Greenland. It is subdivided into 100 øre...

    r itself is partly back by Euro foreign reserve of Danish National Bank

Historical examples

  • Irish pound
    Irish pound
    The Irish pound was the currency of Ireland until 2002. Its ISO 4217 code was IEP, and the usual notation was the prefix £...

    , pegged against pound sterling
    Pound sterling
    The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...

     from independence until 1979.
  • Argentine peso
    Argentine peso
    The peso is the currency of Argentina, identified by the symbol $ preceding the amount in the same way as many countries using dollar currencies. It is subdivided into 100 centavos. Its ISO 4217 code is ARS...

    , pegged against the United States dollar
    United States dollar
    The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....

     until 2002.

See also

  • Central bank
    Central bank
    A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...

  • Dollarization
    Dollarization
    Dollarization occurs when the inhabitants of a country use foreign currency in parallel to or instead of the domestic currency. The term is not only applied to usage of the United States dollar, but generally to the use of any foreign currency as the national currency.The biggest economies to have...

  • Monetary policy
    Monetary policy
    Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

  • Argentine Currency Board
    Argentine Currency Board
    The Argentine Currency Board pegged the Argentine peso to the U.S. dollar between 1991 and 2002 in an attempt to eliminate hyperinflation and stimulate economic growth. While it initially met with considerable success, the board's actions ultimately failed. In contrast of what most people think,...


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 )
  • Arnaldo Mauri, The Currency Board and the rise of banking in British East Africa, W.P. n. 10-2007, Department of Economics, University of Milan.

External links

The source of this article is wikipedia, the free encyclopedia.  The text of this article is licensed under the GFDL.
 
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