Currency Board Arrangement Research Articles

The Philippine currency board arrangement, 1945–48: a case of deflationary bias?

This article provides an historical case study of the hypothesis that a currency board imparts a deflationary bias to a growing economy. The hypothesis is based on the argument that, while economic growth increases the demand for money, the expansion of the money supply in a currency board system is constrained by the balance of payments. After examining the origins, development and criticisms of the deflationary bias hypothesis, the article investigates the experience of the Philippines during its economic recovery from the devastation of the Second World War. The evidence suggests that, under the currency board arrangement then in place, deflationary pressure emerged in the manner predicted by the hypothesis.

Impact of Currency Boards on Fiscal Policy in Central and Eastern European Countries

The paper focuses on the impact of currency boards on fiscal policy in transition economies. Starting with an overview of theoretical and empirical studies in the related area, it tests for the interaction between monetary policy regimes and fiscal policy in Central and Eastern European countries who aim for the membership in the European Union. The theoretical background of this study lies in the model of Tornell and Velasco (1998). They demonstrate that fiscal transfers do not ultimately depend on the chosen exchange rate and monetary policy, but only on the world's real rate of interest and the rate of time preference of the fiscal authority. A sample of 10 accession candidates constitutes a group of countries which go through similar macroeconomic stabilisation processes but have chosen different nominal anchors. The paper investigates whether there are any systematic differences between those countries with a currency board arrangement and those without. The empirical evidence suggests that currency boards enhance fiscal discipline in Central and Eastern European countries.

Choice of Exchange Rate Regime: Currency Board (Hong Kong) or Monitoring Band (Singapore)?

Following the East Asian crisis, a number of observers have advocated that small and open economies in Asia adopt an irrevocably fixed regime. Such a hard peg, it is argued, signals greater commitment to rule out arbitrary exchange rate adjustments as well as the authorities’ willingness to subordinate domestic policy objectives such as output and employment growth to the maintenance of the pegged exchange rate. But is this a reasonable position to adopt? In order to answer this question, we consider and contrast the experiences of Hong Kong and Singapore. While both of these economies share a number of broad similarities, the former operates a US dollar–linked currency board arrangement and the latter maintains an adjustable peg in the form of a monitoring band arrangement with the central parity based on an undisclosed trade–weighted currency basket.

When the Prospective Central and Eastern European Members of the EU Will Be Able to Join the Euro's Zone?

The main objective of this paper is to consider some problems the potential Central and Eastern European Members of the European Union will face before joining ERM II and the euro's area. Their present monetary and exchange rate policies will probably not result in the soonest possible access to Stage 3 of Economic and Monetary Union. This paper presents a view that imminent joining of the ERM II by the post-communist potential members of the EU after enlargement might even cause some complications for them and in consequence delay their access to the euro's area. This paper proposes to introduce currency board arrangement (CBA) to euro as an accession-related adjustment to ERM II and to the euro's area. As a main benefit may be indicated the prospective euroization of their economies and closer links to euro interest rates proven by CBA tied to other currencies in the past. But this requires support from the European Central Bank and the European Commission for such an alternative. The answer for the question formulated in the title will decide about real convergence by CEE countries to the present countries of the EU. It will also allow them sharing benefits from joining the single currency area.

Should Estonia euroize?

Estonia has been operating a currency board arrangement tied to the deutschemark, now the euro, since 1992. Optimal currency area considerations, policy orientation and the flexibility of prices and wages in Estonia support a case for monetary union with the eurozone. But the European Union requires Estonia to wait until EU accession and subsequent Eurosystem accession before it can adopt the euro. In the meanwhile, gains expected from euroization — lower and more stable interest rates, lower transactions costs in trade and increased transparency, all of which would promote trade, investments and economic growth — would be forgone. In this context, the paper raises the question, should Estonia go ahead and euroize now?JEL classification: E42, E58, F33.

A model of contagious currency crises with application to Argentina

This paper proposes a model of contagious currency crises where crises are transmitted across countries through a risk premium effect on government bonds. Three types of equilibria can occur in the model: a ‘no-collapse’ equilibrium in which a crisis is never transmitted from abroad, a ‘collapse’ equilibrium in which a crisis is inevitably contagious, and a ‘fundamentals’ equilibrium in which a crisis is contagious when domestic fundamentals are weak enough. The model is calibrated to the March 1995 Argentine crisis that followed on the heels of the December 1994 Mexican peso crisis. The results imply that the occurrence of the 1995 Argentine crisis reveals a combination of risk aversion of investors and weak credibility in the currency board arrangement. The Argentine crisis however could only be attributed to a ‘tequila effect’ alone (contagion from the Mexican crisis without any role for weak domestic fundamentals) if investors were excessively risk averse.

REAL EXCHANGE RATE BEHAVIOUR UNDER HONG KONG'S LINKED EXCHANGE RATE SYSTEM: AN EMPIRICAL INVESTIGATION

In a behavioural equilibrium exchange rate model, this study investigates the movements of the real exchange rate of the Hong Kong dollar under the currency board arrangement from 1984 to 1998. Cointegration analysis based on Johansen approach is applied to derive the equilibrium real exchange rate in behavioural sense for the Hong Kong dollar. Evidence shows that during the period under investigation, the Hong Kong dollar was initially undervalued when the currency board arrangement was installed. It moved in closer line with the equilibrium rate after 1985 and generally remained moderately undervalued until 1993. Then the currency became overvalued following the upsurge of domestic demand and lingered into 1995 before an adjustment took place latter that year. But except for a few quarters, the overvaluation was not substantial and chronic. On the whole, the Hong Kong dollar seemed to have performed well in the period under examination. In most cases, the currency was actually undervalued. When the Asian financial crisis broke out, the currency was in effect already in a process of adjustment, depreciating form an overvalued level.

Development of the banking system under the Estonian currency board

The choice of a suitable exchange rate regime is the subject of numerous discussions in economic literature. Estonia has been successful in achieving economic stabilization and growth and steadily declining inflation. It has one of the highest per capita foreign direct investments in central and eastern Europe. Estonia also has one of the most liberalized economies among all transition countries. An essential element of the success of Estonian economic development is strict exchange rate control. Estonia has adopted a currency board that serves as a signal of commitment to prudent monetary policy and as a guarantee of sound money during the transition period. This paper discusses the experience of operating the currency board, some future prospects of the currency board arrangement, and the development of the banking system in Estonia.

Lithuania: History and Future of the Currency Board Arrangement

The paper examines the evolution of the institutional setup of Lithuania`s Currency Board Arrangement (CBA) and competitiveness from 1994 through 2001, with a view to determining the resilience of the Lithuanian CBA to external shocks in 2002-03. First, several indicators of competitiveness are analyzed in the context of productivity gains and flexibility of the labor market and prices are considered. Then, the equilibrium exchange rate and misalignments of the actual rate from it are estimated in a cointegration framework. The paper concludes that, under current policies, the CBA would be able to cope with sizable external shocks during 2002-03 provided supporting policies remain in place.

The Estonian Currency Board: Its Introduction and Role in the Early Success of Estonia's Transition to a Market Economy

This paper reviews the history of the introduction of the Estonian kroon under a currency board arrangement. On June 20, 1992, Estonia became the first country from the former Soviet Union to abandon the Russian ruble and introduce its own currency. The paper looks at the factors behind this decision and discusses the implementation of the currency reform. It then assesses the economic impact of the reform and also compares Estonia`s experience with that of its Baltic neighbors. It concludes that although the currency board arrangement made an important contribution to the early success of Estonia`s economic stabilization and reform program the underlying financial and structural policies were crucial for that success.

Macroeconomic Adjustment in a Highly Dollarized Economy: The Case of Cambodia

Cambodia became dollarized suddenly in the early 1990s, as a result of massive dollar inflows stemming from a postconflict situation. Considering that the amount of dollars in circulation is unusually high, we attempt to estimate the true degree of dollarization empirically. Our results show that Cambodia has been virtually fully dollarized since 1995. Against a background of severe institutional limitations, the authorities have implemented in recent years policies akin to those of a de facto currency board arrangement, in particular with respect to fiscal discipline. The paper concludes that this policy mix has been appropriate for Cambodia`s circumstances.

Evolution and Present Status of Bulgarian Card Market

Bulgaria is a small South-eastern European country with a population of 8 million inhabitants in economic transition. During the bank crisis (1996-97) about 1/3 of all banks went bankrupt. On 5 July 1997, the Bulgarian government, jointly with IMF, introduced the Currency Board Arrangement, which lead to economic stabilization and growth. During the last four years the Bulgarian card market has expanded rapidly. The article reviews the evolution and the present status of the Bulgarian card market.

Lithuania: History and Future of the Currency Board Arrangement

Lithuania: History and Future of the Currency Board Arrangement

Currency substitution and speculative attacks on a currency board system

A currency board arrangement (CBA) is supposed to be robust against attacks. Currency substitution complicates life, with controversial implications for floating versus fixed exchange rate regimes. After reporting evidence of currency substitution in Hong Kong, a monetary model incorporating currency substitution is used to estimate the shadow exchange rate and the probability of speculative attack on the Hong Kong dollar. A decomposition analysis of a Markov-switching model indicates that the no-attack regime was the most durable one. This implies that Hong Kong's quasi CBA was relatively robust against both speculative attacks and currency substitution.

Currency Board Arrangement to Euro as a Stage for Prospective EU Members to Join the Euro's Zone

The main objective of this paper is to create an option for the present East European monetary and exchange rate policy that should result in the soonest possible access to Stage 3 of Economic and Monetary Union. This paper proposes to introduce currency board arrangement tied with Euro as an accession-related adjustment to ERM II and to the euro's area. To prove necessity of such solution this paper develops the potential dangers of imminent joining ERM II by the post-communist potential members of the EU and potential benefits of supporting CBA tied with Euro and adopting it before joining ERM II by these countries. As a main benefit may be indicated the prospective euroization of their economies and closer links to euro interest rates proven by CBA tied to other currencies in the past. But this requires support from the European Central Bank and the European Council for such an alternative.

Bulgaria: 2000 Article IV Consultation and Fifth Review Under the Extended Arrangement--Staff Report; Staff Statement; Public Information Notice and News Brief on the Executive Board Discussion; and Statement by the Authorities of Bulgaria

Bulgaria’s currency board arrangement continues to have broad political and public support and shows no signs of strain, as interest rates are low and stable, fiscal reserves ample, and banks liquid. A structural reform agenda has also been implemented. The authorities have improved banking supervision, started the overhaul of the pension and health care systems, and liberalized trade and prices. Executive Directors stressed the need to strengthen the bank supervision and corporate governance to reduce the perceived risks of lending to the private sector.

Currency board arrangement in Estonia: History and future prospects

Currency board arrangement in Estonia: History and future prospects

Currency Boards, Credibility, and Macroeconomic Behavior

Currency boards operate differently from standard pegs. The former exhibit greater currency stability and lower transaction costs, inflation, and nominal interest rates, but are limited in their use of devaluation. We extend Drazen and Masson's (1994) signaling model to consider the choice between currency board arrangements and standard pegs. The model shows that currency boards' effectiveness hinges on their credibility properties and that they can improve welfare even with high unemployment persistence. By reducing expected inflation and the negative employment effect arising from expected but unrealized inflation, currency boards can produce less unemployment than peg regimes that abstain from devaluation.

Currency Boards, Credibility, and Macroeconomic Behavior

Currency boards operate differently from standard pegs. The former exhibit greater currency stability and lower transaction costs, inflation, and nominal interest rates, but are limited in their use of devaluation. We extend Drazen and Masson’s (1994) signaling model to consider the choice between currency board arrangements and standard pegs. The model shows that currency boards’ effectiveness hinges on their credibility properties and that they can improve welfare even with high unemployment persistence. By reducing expected inflation and the negative employment effect arising from expected but unrealized inflation, currency boards can produce less unemployment than peg regimes that abstain from devaluation.

Exchange Rate Regimes in Selected Advanced Transition Economies

Since beginning economic transition, the Czech Republic, Estonia, Hungary, Poland, and Slovenia have—with much success—employed diverse exchange rate regimes. As these countries approach EU accession, they will need to avoid the perils of too much or too little exchange rate variability when capital flows are likely to be large and volatile; narrow band arrangements in particular could be problematic. The exception is Estonia, where there are good arguments for retaining the currency board arrangement. Countries wishing to join the euro area at an early stage should not leave the removal of remaining capital controls to the last minute.