Currency Board Research Articles

A Market Economy Manifesto for Bulgaria

Professor Hanke served as an adviser to Bulgarian President Petar Stoyanov, from 1997 to 2002. In 1997, Bulgaria adopted a Currency Board System, based on Professor Hanke's draft Currency Board Law, which he authored at the request of President Stoyanov. The Currency Board brought an end to Bulgaria's hyperinflation which peaked with a monthly inflation rate of 242%, in February 1997.This paper was original presented as the keynote address, delivered at the Investment Forum 2002, Sofia. In that 2002 keynote speech, Professor Hanke advocated a flat tax for Bulgaria. In 2008, Bulgaria followed that recommendation and adopted a flat tax rate of 10% on personal and corporate income.

Latvia Trapped in an Exchange Rate Peg

CEEC-10, after the effort made to join the European Union, are now facing another challenge: replacing their national currencies with the euro. Each of them will have to take the entry test – the EU Maastricht convergence criteria. Recently, Baltic countries after a decade of spectacular economic growth experience inflation motivated problems. For countries having a currency board or fixed exchange rates high inflation may trigger a dangerous feedback between higher and higher growth and negative real interest rates. In 2007 Latvia was trapped in such a scenario. Latvian lat got very close to the weak end of the narrow fluctuation band for LVL/EUR. Latvijas Banka, however, immediately, took a set of measures that weakened the pressure on lat and were also aimed at lowering inflation and stabilizing the economic growth. So far the instruments used have been effective. Still, the threat persists.

Inflation and Sectoral Output Growth Variability in Bulgaria

This paper analyzes the relationship between inflation and sectoral output growth variability in Bulgaria using a monthly data set from 2000:01 to 2012:08. The Bulgarian economy is working under a unique currency board setting that exclusively allows the government to influence the money supply through its fiscal position on the asset side of the central bank's balance sheet. Abrupt relative price changes across sectors bring fluctuations in sectoral output growth. Nevertheless, inflation effects on average output growth are positive and linear. Besides, persistent real exchange rate appreciation causes lower growth and higher variability under the pegged exchange rate regime.

Inflation Uncertainty, Output Growth Uncertainty and Macroeconomic Performance Comparing Alternative Exchange Rate Regimes in Eastern Europe

In the late 90's, after severe financial and economic crisis, accompanied by inflation and exchange rate instability, Eastern Europe emerged into two groups of countries with radically contrasting monetary regimes (Currency Boards and Inflation targeting). The task of our study is to compare econometrically the performance of these two regimes in terms of the relationship between inflation, output growth, nominal and real uncertainties from 2000 till now. In other words, we test the hypothesis of non-neutrality of monetary and exchange rate regimes with respect to these connections. In a whole, the empirical results do not allow us to judge which monetary regime is more appropriate and reasonable to assume. EU enlargement is one of the possible explanations for the numbing of the differences and the lack of coherence between the two regimes in terms of inflation, growth and their uncertainties

Did Argentina Have a Currency Boards in the Mid 1880'S?

My research was part of a larger project to determine how currency board monetary systems have performed. The goal was to find information about the note issue of Argentina's Banco de la Provincia in the mid 1800's in order to determine if Argentina had a currency board system. I also tried to find answers to the questions of why the note issue arrangement was established, how it worked organizationally and why it was replaced.

Monetary regimes, economic stability, and EU accession: Comparing Bulgaria and Romania

This paper traces the origins of the different monetary regimes adopted in Bulgaria and Romania in 1996–97 and examines their performance during the EU accession. The findings indicate that the constraints of the currency board in Bulgaria shifted economic activity towards the private sector, while the discretionary policies in Romania turned public finances into both a contributor and a response mechanism to economic imbalances. While the prospects of EU accession initially enhanced the performance of the monetary anchors, the implicit insurance of EU membership increased moral hazard and led to a rapid rise in private and public debt. The paper also explores the historical parallels between the monetary regimes of Bulgaria and Romania in 1996–97 and 1925–1940.

Labour market and labour market policies during great recession: the case of Estonia

The purpose of the paper is to analyse how labour market and labour market institutions reacted during recent crises. In early 1990s Estonia introduced a set of rather unique policy options like currency board as a ground for monetary policy, low taxes, open foreign trade policy, low public sector debts, annually balanced state budget etc. These measures caused very limited options to implement both monetary and fiscal policy. Macroeconomic adjustment will take place in such situation through the labour market. In the case of Estonia, we can observe a very high labour market flexibility, which played a crucial role in recent economic recession. The measures taken included a reduction of nominal wages, working hours and redundancies among employees. This indicates that the traditional institutional factors that protect workers and also could decrease the flexibility of the labour market, such as labour market regulation, social protection and union activities, are not very well developed in Estonia and do not have a significant effect on the outcomes of the labour market. The labour market reform was launched in Estonia in 2009. The main idea of the New Employment contract was that the termination of employment relations became less expensive for employers. Although empirical evidence show that the Employment Contracts Act entered into force at a time when most lay-offs had already been effected. J08, J21, J50, J63

A Cointegration Analysis of Inflation and Real Estate Returns

Executive Summary. This study investigates the causal relationship between inflation and property returns and the short- and long-term inflation hedging effectiveness of property assets in Hong Kong. The results show that residential property is the only property type providing an effective hedge against actual, expected, and unexpected inflation during the sample period. The autoregressive distributed lag (ARDL) bounds testing results indicate that inflation and property are cointegrated. The causality results support that inflation leads property returns, but not vice versa. The one-way causality between inflation and real estate returns can be better explained by the operation of the Hong Kong currency board system as investment funds flow to the risky real estate assets from banking deposits due to the prospect of lower or even negative interest rates caused by rising inflation in Hong Kong.

Monetary institutions and inflation performance: cross-country evidence

This paper presents an empirical investigation of the effectiveness of the institutional frameworks of monetary policy in achieving and maintaining price stability. The institutional frameworks considered are central bank independence (CBI), inflation targeting (IT), currency boards (CB) and monetary unions (MU). Against the vast literature that argues for the price stabilizing effects of each of these institutions, the empirical evidence presented here suggests that countries that have adopted the IT and CB regimes have, on average, been associated with lower inflation rates than others during the past decade. This finding is robust to various control variables, while governance appears to be a substitute to formal mechanisms.

Bulgaria: Fifteen Years Later

In this paper I reflect on my experiences in Bulgaria, where I served as President Stoyanov's adviser and played a major role in establishing Bulgaria's currency board. The first of July marked the anniversary of a momentous day in Bulgarian history. On that day, fifteen years ago, Bulgaria installed its currency board system (CBS), finally ending its hyperinflation, which had peaked with a monthly inflation rate of 242%, in February 1997. Armed with a currency board system, Bulgarians overcame the hyperinflation crisis of 1996-97 and finally began to realize stability and economic growth. Now, it’s time to get serious about Bulgaria’s biggest problem: corruption.

Poverty, Income Distribution and CGE Micro-Simulation Modelling: Does Individual Behaviour Matter?

This paper aims to contribute to the shared goal of assessing the distributional consequences of macroeconomic shocks and policies. It does so by looking into the domain of applicability of the different microsimulation approaches used at present in combination with macroeconomic CGE models. In this context, the microsimulation approach that is used is not always clearly defined and justified (Boccanfuso, Decaluwe et al. 2008). Frequently used approaches are illustrated here considering the distributional effects of the significant capital outflows faced by the Argentinean economy at the end of its Currency Board Regime. It is found that behavioral microsimulations, by accounting for the role of individuals’ heterogeneity on their employment status, allows us to throw light on significant distributional effects that other approaches do not allow us to see. However, the straightforward ‘non-parametric’ approach leads to distributional results not significantly different, consistently with Herault (2010) finding. Contrasting the existing approaches against Orcutt (1957) vision, a possible direction for future research is suggested.

Modelling Trade and Financial Liberalisation Effects for Argentina

This thesis is a response to the growing recognition that the workings of the financial sphere significantly affect the value of social production, its distribution, and the magnitude of income poverty. The thesis extends a general equilibrium single-country model targeted to a developing economy (the IFPRI Standard Model) to account for the workings of the financial sphere and 'money in the production function', in the tradition begun by Milton Friedman (1969). The models are calibrated and their workings are analysed. It is found that the inclusion of 'money in the production function' by itself only causes financial outcomes to significantly affect the overall level of production and the unemployment rate in the presence of strong wage rigidities. This is explained in terms of the model parameters. The extended model is employed in a stylised static way to identify the short-run stresses generated by current and capital account liberalisation in Argentina during its Currency Board Regime, adopted over 1991-2001, with the finding that in the short-run the volatility of capital flows was transmitted to employment and activity levels. The model is then linked in a sequential way to a behavioural microsimulations model, separating out the different transmission channels involved. It is found that the significant capital outflows witnessed by the country surrounding the end of its Currency Board Regime worsened poverty and inequality indicators in the country, and that the main transmission channel through which the capital outflow had the most distributional impact was the selectivity of labour market rationing.

Exchange Rate Choices of Microstates

In this paper I first explain why most microstates (countries with less than two million inhabitants) have gained independence only in the last 30 years. Despite the higher costs and risks microstates face, their ability to better accommodate local preferences, combined with a more integrated world economy, probably explains why there are now more benefits to independence. I explain why microstates at independence have chosen either dollarization, currency board arrangements, or fixed exchange rates rather than more flexible forms of exchange rate systems. I then, using the Geweke-Hajivassiliou-Keane multivariate normal simulator, model empirically the determinants of each of the different fixed exchange rate regimes in microstates and analyze the policy implications.

Can Japan or China replace the US as the monetary anchor for Hong Kong and Macau?

This contribution attempts to examine the relative importance of the US, Japan and China to Hong Kong and Macau, two effective dollar-based currency boards today, by evaluating the economic potentiality of Japan or China as an alternative monetary anchor country against the US. The assessment is made according to the criteria prescribed by the optimum currency areas (OCA) theory. In addition to that, a subsidiary analysis is done to evaluate in general the suitability of their fixed exchange rate regimes, regardless of the anchor country. Amidst the existing dollar linked arrangement and the rising dominance of China, significant evidence suggests that Japan, despite its lacklustre domestic conditions, might be at least as good a monetary anchor as the US for Hong Kong. In the meantime, China seems to be a more promising monetary anchor alternative for Macau. The features of Hong Kong and Macau also appear to broadly and endogenously support their fixed exchange rates, but not all the features of Macau, a HK-dollar-based currency board, are consistently symmetrical with those of Hong Kong.

Inside the Currency Board Arrangement Risky Spreads and Credit Default Swap - Sovereign Bonds Basis

The paper investigates the risky sovereign spreads and the CDS-Bond basis of a country following a fixed exchange rate under a Currency Board Arrangement (CBA). The particular monetary regime affects significantly the mechanics of the bond market and needs a special investigation. We start by characterizing the drivers of the spreads in a general no-arbitrage setting. Both the credit and the currency components are extracted and analyzed. Then we turn attention to the CDS-Bond basis. We elaborate on its measurement in a multi-curve framework. Further, the factors driving the basis are explored across a representative set of CBA countries. The results of the paper provide a view about the proper diagnostics of the sovereign risk and can be used for a better understanding of the price discovery process of the sovereign bonds as well as in relative value analysis.

INTRODUCTION: DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM MODELLING AND THE STUDY OF ASIA‐PACIFIC ECONOMIES

INTRODUCTION: DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM MODELLING AND THE STUDY OF ASIA‐PACIFIC ECONOMIES

MACROECONOMIC VOLATILITY AND COUNTERFACTUAL INFLATION‐TARGETING IN HONG KONG

AbstractThe present paper evaluates macroeconomic adjustment in Hong Kong with an estimated dynamic stochastic general equilibrium (DSGE) model under a fixed exchange rate regime. We find that exports and world inflation shocks are the dominant sources of GDP volatility, with the risk premium taking on importance during the Asian crisis after 1997. A counterfactual simulation, assuming a flexible exchange rate regime with inflation targeting, shows that inflation would have decreased slightly, but interest‐rate volatility would have increased significantly. The welfare gains from switching out of the currency board system appear to be marginal.

The Sustainability of Monetary Unions - Can the Euro Survive?

This paper aims to propose a new measure of exchange market pressure for countries operating in hard peg regimes, such as currency unions, currency boards or full dollarization. We use a general model of currency crisis to derive a sustainability index based upon the relationship between the shadow exchange rate and the output gap required to maintain the currency peg. We apply the new index to European Union countries in order to assess the sustainability of the Euro.

Currency Board Arrangements: Arguments For and Against Adoption in Indonesia

Tulisan ini mendiskusikan argumen-argumen pro-kontra perancangan “currency board“ di Indonesia. Pada waktu krisis ekonomi melanda Indonesia, pemerintah pernah mempertimbangkan kemungkinan pengadopsian “currency board“ guna mengatasi krisis dan menstabilkan perekonomian. Berdasarkan perdebatan panjang mengenai keuntungan dan kerugian penerapan “currency board“ di Indonesia, dapat disimpulkan bahwasanya “necessary condition“ bagi Indonesia untuk mengadopsi “currency board“ selama krisis tidak terpenuhi. Indonesia tidak mempunyai cukup cadangan valuta asing untuk menyokong basis moneter dan sistem perbankan belum siap menerima kondisi “no the lender of last resort.” Keputusan untuk tidak menerapkan “currency board” selama krisis ekonomi merupakan keputusan yang rasional.

The Euro Crisis and the Job Guarantee: A Proposal for Ireland

Euroland is in a crisis that is slowly but surely spreading from one periphery country to another; it will eventually reach the center. The blame is mostly heaped upon supposedly profligate consumption by Mediterraneans. But that surely cannot apply to Ireland and Iceland. In both cases, these nations adopted the neoliberal attitude toward banks that was pushed by policymakers in Europe and America, with disastrous results. The banks blew up in a speculative fever and then expected their governments to absorb all the losses. The situation was similar in the United States, but in our case the debts were in dollars and our sovereign currency issuer simply spent, lent, and guaranteed 29 trillion dollars’ worth of bad bank decisions. Even in our case it was a huge mistake — but it was “affordable.” Ireland and Iceland were not so lucky, as their bank debts were in “foreign” currencies. By this I mean that even though Irish bank debt was in euros, the Government of Ireland had given up its own currency in favor of what is essentially a foreign currency — the euro, which is issued by the European Central Bank (ECB). Every euro issued in Ireland is ultimately convertible, one to one, to an ECB euro. There is neither the possibility of depreciating the Irish euro nor the possibility of creating ECB euros as necessary to meet demands for clearing. Ireland is in a situation similar to that of Argentina a decade ago, when it adopted a currency board based on the US dollar. And yet the authorities demand more austerity, to further reduce growth rates. As both Ireland and Greece have found out, austerity does not mean reduced budget deficits, because tax revenues fall faster than spending can be cut. Indeed, as I write this, Athens has exploded in riots. Is there an alternative path? In this piece I argue that there is. First, I quickly summarize the financial foibles of Iceland and Ireland. I will then — also quickly — summarize the case for debt relief or default. Then I will present a program of direct job creation that could put Ireland on the path to recovery. Understanding the financial problems and solutions puts the jobs program proposal in the proper perspective: a full implementation of a job guarantee cannot occur within the current financial arrangements. Still, something can be done.