Currency Board
What Is a Currency Board?
A currency board is an extreme form of a pegged exchange rate. Management of the exchange rate and the money supply are detracted from the country's central bank, assuming that it has one. Notwithstanding a fixed exchange rate, a currency board is likewise generally required to keep up with reserves of the underlying foreign currency.
How a Currency Board Works
Under a currency board, the management of the exchange rate and money supply are given to a monetary authority that settles on conclusions about the valuation of a country's currency. Frequently, this monetary authority has direct guidelines to move all units of domestic currency in circulation with foreign currency. At the point when all domestic currency is backed with foreign currency, it is called a 100% reserve requirement. With a 100% reserve requirement, a currency board operates in much the same way to a strong rendition of the gold standard.
The currency board takes into consideration the unlimited exchange of the domestic currency for foreign currency. A conventional central bank can print money voluntarily, yet a currency board must back extra units of currency with foreign currency. A currency board procures interest from foreign reserves, so domestic interest rates normally copy the predominant rates in the foreign currency.
Currency Boards versus Central Banks
Like the greater part of the world's large economies, the U.S. doesn't have a currency board. In the United States, the Federal Reserve is a true central bank, which operates as a lender of last resort. The exchange rate is permitted to not entirely settled by market powers, as well as the Fed's monetary policies.
Conversely, currency boards are to some degree limited an option for them. They for the most part just hold the required percentage of pegged currency that was recently ordered. They additionally exchange neighborhood currency for the pegged (or anchor) currency, which is normally the U.S. dollar or the euro.
A currency board has less power to mischief or help the economy than a central bank.
Benefits of a Currency Board
Currency board systems are frequently commended for their relative stability and rule-based nature. Currency boards offer stable exchange rates, which advance trade and investment. Their discipline confines government actions. Inefficient or flighty governments can't just print money to pay down shortages. Currency boards are known for keeping inflation taken care of.
Hindrances of a Currency Board
Currency boards likewise have downsides. In fixed exchange-rate systems, currency boards don't permit the government to set their interest rates. That means economic conditions in a foreign country typically decide interest rates. By pegging the domestic currency to a foreign currency, the currency board imports a lot of that foreign country's monetary policy.
At the point when two countries are at various points in the business cycle, a currency board can make serious issues. For instance, assume the central bank raises interest rates to limit inflation during an expansion in the foreign country. The currency board communicates that rate climb to the domestic economy, paying little mind to neighborhood conditions. On the off chance that the country with a currency board is now in a recession, the rate climb could exacerbate it.
In a crisis, a currency board can cause even more damage. Assuming that investors offload their nearby currency rapidly and simultaneously, interest rates can rise fast. That compromises the ability of banks to keep up with legally required reserves and suitable liquidity levels.
Such a banking crisis can deteriorate fast since currency boards can't act as a lender of last resort. In the event of a banking panic, a currency board can't loan money to banks in a significant manner.
Real World Example of a Currency Board
Hong Kong has a currency board that keeps a fixed exchange rate between the U.S. dollar and the Hong Kong dollar. Hong Kong's currency board has a 100% reserve requirement, so all Hong Kong dollars are completely backed with U.S. dollars. While the currency board contributed to Hong Kong's trade with the U.S., it likewise demolished the impact of the 1997 Asian financial crisis.
Features
- A currency board is an extreme form of a pegged exchange rate.
- In a crisis, a currency board can cause substantial damage by confining monetary policy.
- Frequently, this monetary authority has direct guidelines to move all units of domestic currency in circulation with foreign currency.
- Currency boards offer stable exchange rates, which advance trade and investment.
