Kong's Currency Board Research Articles

The Credibility of Hong Kong's Currency Board System: Looking Through the Prism of MS‐VAR Models with Time‐Varying Transition Probabilities

AbstractThis paper employs a Markov regime‐switching VAR model to describe and analyse the time‐varying credibility of Hong Kong's currency board system. The endogenously estimated discrete regime shifts are made dependent on macroeconomic fundamentals. This enables us to determine which changes in macroeconomic variables can trigger switches between the low and high credibility regimes. We carry out extensive testing to search for the most appropriate specification of the Markov regime‐switching model. We find strong evidence of regime switching behaviour that portrays the time‐varying nature of credibility in the historical data.

The Credibility of Hong Kong's Currency Board System: Looking Through the Prism of MS-VAR Models with Time-Varying Transition Probabilities

The Credibility of Hong Kong's Currency Board System: Looking Through the Prism of MS-VAR Models with Time-Varying Transition Probabilities

Off-the-Record Target Zones: Theory with an Application to Hong Kong's Currency Board

This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmetric one-sided regimes. Market participants' beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong's one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities finally revamped the regime as a symmetric two-sided system with a narrow exchange rate band.

A Currency Board Model of Hong Kong

The need for a deeper understanding of the operation of Hong Kong's currency board arrangements was highlighted during the Asian financial crisis in 1998. A model-based approach built on hypothetical stochastic simulations would be useful for this purpose. This paper develops a new procedure of implementing stochastic simulations in a currency board model for Hong Kong. Our new procedure is useful in the context of a nonlinear model with forward-looking expectations under conditions of noncertainty- equivalence, such as the model of Hong Kong's currency board. A simple target-zone model of the exchange rate is used as an example to illustrate the difference between our new simulation procedure and existing procedures in the literature. Finally, the new procedure is applied to the currency board model to investigate the stochastic properties of endogenous variables under a wide range of shocks.

Rules Versus Discretion in Managing the Hong Kong Dollar, 1983-2006

This paper examines the way in which Hong Kong's currency board has operated since its re-introduction in 1983. It discusses currency board design and the extent to which Hong Kong has conformed to particular principles. The core of the paper is an assessment of the rules-versus-discretion question. From 1983 to 1988 the currency board convertibility obligation applied, in effect, to physical cash only. Arbitrage could not be relied upon to ensure that the market rate converged to 7.80, so intervention - mostly in the foreign exchange market - played a significant role. In 1988 the authorities acquired the means to apply currency board principles also to the reserve balance of the banking system, but over the next ten years they did not exploit that to full advantage in the currency board context. They gave no convertibility promise for the reserve balance and seldom allowed foreign exchange transactions to trigger currency-board-type adjustment. They concentrated instead on managing bank liquidity or interest rates, very often via money market intervention, albeit subject to the overriding goal of a stable exchange rate. But the range which defined that stability was never revealed. Although this exercise of discretion and the departures from strict currency board principles were not obviously damaging, they may have complicated official procedures unnecessarily, and may have raised doubts as to the authorities' long-term commitment to 7.80. In other words, rather than helping to settle markets, the tactics may at times have disturbed them. Reforms in 1998 included a weak-side convertibility undertaking for banks' reserve money at 7.80 (after transition), but left strong-side intervention to the discretion of the Monetary Authority. It was only in 2005 that a firm strong-side undertaking was introduced at 7.75, with the weak side bound being moved to 7.85 in order to provide symmetry. Now, only one minor element of discretion - for intrazone intervention - remains. Whereas discretionary interventions were probably very necessary in the early years after 1983, the authorities could have moved more quickly after 1988 to reach the almost completely rule-based status of today. But the stability of the exchange rate over the entire period speaks for itself, and it is not obvious that stricter adherence to currency board principles would have delivered a materially different outcome.

Monetary operations by Hong Kong's Currency Board

Currency Boards are typically seen as demonstrating the advantages of rule-bound monetary policies with automatic responses to exchange market imbalances. We study the monetary operations conducted by Hong Kong's Currency Board, using daily data between September 1998 and December 2001. Since this regime is one-sided in that there is a commitment to sell, but not to buy, US dollars at a given rate, we estimate logit equations for dollar purchases. We show that these have shifted over time and that while the variables are statistically highly significant, the predictive power is low.

Exchange Rate Regimes for Emerging Market Economies: Lessons from Asia

This article discusses the role of the exchange rate regime in the 1997 East Asian crisis. Most of the countries had, more or less, fixed-but-adjustable exchange rate regimes before the crisis. The article outlines special problems of this regime when there is high capital mobility, including the loss of political credibility that results when governments cannot maintain fixed exchange rates to which they have committed. The article discusses how the crisis would have played out under alternative exchange rate regimes, namely floating rates and currency boards. There would still have been a boom followed by a crisis, though in the short run, the recessions might have been less deep. The article also discusses Hong Kong's currency board regime; the reasons the Indonesian crisis was especially severe; the reasons some Asian countries, notably India, avoided a crisis; and the role of capital controls, especially in Malaysia.

The Impacts of Hong Kong's Currency Board Reforms on the Interbank Market

Among the economies with a Currency Board System, Hong Kong is probably the one with (a) the largest and most developed financial sector, and (b) the highest capital mobility. Hence, studying Hong Kong's Currency Board System is not only crucial to Hong Kong, but also important for the understanding of the modern Currency Board System. This paper outlines the major monetary reforms in Hong Kong since the late 1980s. The impacts of these reforms and the 1997/98 Asian Financial Crisis are then examined empirically. We focus on the differentials between the US and Hong Kong interbank interest rates. Generalized autoregressive conditional heteroscedasticity (GARCH) models are used to capture the time-varying level and volatility of the differentials. In light of the empirical results we provide an assessment of the reforms in Hong Kong.

Hong Kong's exchange rate regime:: Lessons from Singapore

Singapore's managed floating exchange rate regime contrasts with Hong Kong's currency board system featured by the Hong Kong–United States dollars peg. This paper appraises the two different exchange rate regimes by comparing their track records in maintaining macroeconomic stability and trade competitiveness in the 1990s. A review of the two regimes' institutional characteristics and macroeconomic performance reveals the systemic inadequacy of Hong Kong's exchange rate regime under a changing global financial environment. As East Asia emerges from the recent financial crisis, Singapore's experience of successfully moving away from a currency board system to a credible managed floating regime offers a lesson worthy of attention from Hong Kong.