public finance Public finance refers to the monetary resources available to governments and also to the study of finance within government and role of the government in the economy. Within academic settings, public finance is a widely studied subject in man ...

, a currency board is a mechanism by which a

monetary authority A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monet ...

is required to maintain a

fixed exchange rate A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a currency basket, basket of other currenc ...

with a foreign

currency A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a ''system of money'' in common use within a specific envi ...

by fully backing the commitment with foreign holdings, or reserves. This policy objective requires the conventional objectives of a

central bank A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...

to be subordinated to the exchange rate target. Although a currency board is a common (and simple) way of maintaining a fixed exchange rate, it is not the only way. Countries often keep exchange rates within a narrow band by regulating balance of payments through various

capital control Capital controls are residency-based measures such as transaction taxes, other limits, or outright prohibitions that a nation's government can use to regulate flows from capital markets into and out of the country's capital account. These meas ...

s, or though international agreements, among other methods. Thus, a rough peg may be maintained without a currency board.

History

In colonial administration, currency boards were popular because of the advantages of printing appropriate denominations for local conditions, and it also benefited the colony with the

seigniorage Seigniorage , also spelled seignorage or seigneurage (), is the increase in the value of money due to money creation minus the cost of producing the additional money. Monetary seigniorage is where government bonds are exchanged for newly create ...

revenue. The first such case was the Board of Commissioners of Currency of Mauritius, established in 1849. Other notable cases included the West African Currency Board (est. 1912), East African Currency Board (est. 1919), and successive boards serving the

Straits Settlements The Straits Settlements () were a group of British territories located in Southeast Asia. Originally established in 1826 as part of the territories controlled by the British East India Company, the Straits Settlements came under control of the ...

then British Malaya. However, after

World War II World War II or the Second World War (1 September 1939 – 2 September 1945) was a World war, global conflict between two coalitions: the Allies of World War II, Allies and the Axis powers. World War II by country, Nearly all of the wo ...

many independent countries preferred to have central banks and independent currencies. Currency board arrangements experienced a revival of popularity in the late 20th century following negative experiences with inflation. Unlike in the colonial era, they were typically implemented by existing central banks whose mandate was correspondingly restricted.

Overview

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 bank creditors of a Reserve Account at the currency board) can convert them into the reserve currency (usually 110–115% of the monetary base 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 interest 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 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 is the policy adopted by the monetary authority of a nation to affect monetary and other financial conditions to accomplish broader objectives like high employment and price stability (normally interpreted as a low and stable rat ...

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 In public finance, a lender of last resort (LOLR) is a financial entity, generally a central bank, that acts as the provider of liquidity to a financial institution which finds itself unable to obtain sufficient liquidity in the interbank ...

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 is a type of government-issued currency that is not backed by a precious metal, such as gold or silver, nor by any other tangible asset or commodity. Fiat currency is typically designated by the issuing government to be legal tende ...

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 In macroeconomics, hard currency, safe-haven currency, or strong currency is any globally traded currency that serves as a reliable and stable store of value. Factors contributing to a currency's ''hard'' status might include the stability and ...

such as the U.S. dollar or the

euro The euro (currency symbol, symbol: euro sign, €; ISO 4217, currency code: EUR) is the official currency of 20 of the Member state of the European Union, member states of the European Union. This group of states is officially known as the ...

). The surplus on the balance of payments 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 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

More than 70 countries have had currency boards. Currency boards were most widespread in the early and mid 20th century. Foreign currency uses and pegs

Hong Kong Hong Kong)., Legally Hong Kong, China in international treaties and organizations. is a special administrative region of China. With 7.5 million residents in a territory, Hong Kong is the fourth most densely populated region in the wor ...

operates a currency board (

Hong Kong Monetary Authority The Hong Kong Monetary Authority (HKMA) is the central bank, central banking institution of Hong Kong. It is a government authority founded on 1 April 1993 when the Office of the Exchange Fund and the Office of the Commissioner of Banking merge ...

), as does

Bulgaria Bulgaria, officially the Republic of Bulgaria, is a country in Southeast Europe. It is situated on the eastern portion of the Balkans directly south of the Danube river and west of the Black Sea. Bulgaria is bordered by Greece and Turkey t ...

Estonia Estonia, officially the Republic of Estonia, is a country in Northern Europe. It is bordered to the north by the Gulf of Finland across from Finland, to the west by the Baltic Sea across from Sweden, to the south by Latvia, and to the east by Ru ...

had a currency board fixed to the

Deutsche Mark The Deutsche Mark (; "German mark (currency), mark"), abbreviated "DM" or "D-Mark" (), was the official currency of West Germany from 1948 until 1990 and later of unified Germany from 1990 until the adoption of the euro in 2002. In English, it ...

from 1992 to 1999, when it switched to fixing to the

Euro The euro (currency symbol, symbol: euro sign, €; ISO 4217, currency code: EUR) is the official currency of 20 of the Member state of the European Union, member states of the European Union. This group of states is officially known as the ...

at par. The peg to the Euro was upheld until January 2011 with Estonia's adoption of the Euro (see Economy of Estonia for a detailed description of the Estonian currency board).

Argentina Argentina, officially the Argentine Republic, is a country in the southern half of South America. It covers an area of , making it the List of South American countries by area, second-largest country in South America after Brazil, the fourt ...

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. They argue that Argentina's monetary system was an inconsistent mixture of currency board and central banking elements. It is also thought that the 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 The British Overseas Territories (BOTs) or alternatively referred to as the United Kingdom Overseas Territories (UKOTs) are the fourteen dependent territory, territories with a constitutional and historical link with the United Kingdom that, ...

Gibraltar Gibraltar ( , ) is a British Overseas Territories, British Overseas Territory and British overseas cities, city located at the southern tip of the Iberian Peninsula, on the Bay of Gibraltar, near the exit of the Mediterranean Sea into the A ...

, the

Falkland Islands The Falkland Islands (; ), commonly referred to as The Falklands, is an archipelago in the South Atlantic Ocean on the Patagonian Shelf. The principal islands are about east of South America's southern Patagonian coast and from Cape Dub ...

and St. Helena continue to operate currency boards, backing their locally printed currency notes with sterling reserves.History of the Monetary Systems and the Public Finances in the Bahamas, 1946-2003
/ref> 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 * Bosnia and Herzegovina convertible mark (''Konvertibilna marka'')

Examples against the U.S. dollar

* Hong Kong dollar * Bermudian dollar * Cayman Islands dollar * Djiboutian franc * East Caribbean dollar (

Antigua Antigua ( ; ), also known as Waladli or Wadadli by the local population, is an island in the Lesser Antilles. It is one of the Leeward Islands in the Caribbean region and the most populous island of the country of Antigua and Barbuda. Antigua ...

and Barbuda,

Dominica Dominica, officially the Commonwealth of Dominica, is an island country in the Caribbean. It is part of the Windward Islands chain in the Lesser Antilles archipelago in the Caribbean Sea. The capital, Roseau, is located on the western side of t ...

Grenada Grenada is an island country of the West Indies in the eastern Caribbean Sea. The southernmost of the Windward Islands, Grenada is directly south of Saint Vincent and the Grenadines and about north of Trinidad and Tobago, Trinidad and the So ...

Saint Kitts and Nevis Saint Kitts and Nevis, officially the Federation of Saint Christopher (St Kitts) and Nevis, is an island country consisting of the two islands of Saint Kitts and Nevis, both located in the West Indies, in the Leeward Islands chain of the Less ...

Saint Lucia Saint Lucia is an island country of the West Indies in the eastern Caribbean. Part of the Windward Islands of the Lesser Antilles, it is located north/northeast of the island of Saint Vincent (Saint Vincent and the Grenadines), Saint Vincent ...

, and Saint Vincent and the Grenadines) ** For complete listing, see

United States dollar The United States dollar (Currency symbol, symbol: Dollar sign, $; ISO 4217, currency code: USD) is the official currency of the United States and International use of the U.S. dollar, several other countries. The Coinage Act of 1792 introdu ...

Examples against the pound sterling

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, £. The ISO 4217 currency code is ''FKP''. The Falkland Islands pound has always been Fixed exchange rate, ...

Gibraltar pound The pound ( sign: £; ISO code: GIP) is the currency of Gibraltar. It is pegged to – and exchangeable with – British pound sterling at par value. Coins and banknotes of the Gibraltar pound are issued by the Government of Gibraltar. His ...

Saint Helena pound The Saint Helena pound is the currency of the Atlantic islands of Saint Helena and Ascension, which are constituent parts of the British Overseas Territory of Saint Helena, Ascension and Tristan da Cunha. It is fixed at parity with sterling, ...

Examples against other currencies

* Brunei dollar, against the

Singapore dollar The Singapore dollar (currency sign, sign: S$; ISO 4217, code: SGD) is the official currency of the Singapore, Republic of Singapore. It is divided into 100 cent (currency), cents (, , ). It is normally abbreviated with the dollar sign $, or ...

* Macanese pataca, against the Hong Kong dollar * The

Faroe Islands The Faroe Islands ( ) (alt. the Faroes) are an archipelago in the North Atlantic Ocean and an autonomous territory of the Danish Realm, Kingdom of Denmark. Located between Iceland, Norway, and the United Kingdom, the islands have a populat ...

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 kroner. The Danish National Bank refers to the Faroese króna as a "special version" of the Danish kroner, which is itself partly backed by the Euro foreign reserve of the Danish National Bank.

Past examples

* Argentine peso, pegged against the

from 1991 until 2002. * Bahraini dinar, fixed against the

pound sterling Sterling (symbol: £; currency code: GBP) is the currency of the United Kingdom and nine of its associated territories. The pound is the main unit of sterling, and the word '' pound'' is also used to refer to the British currency general ...

from 1966 until 1973. * Bahamian pound, fixed against the

from 1921 until 1966 * Bahamian dollar was fixed against the

from 1966 until 1968. * Bosnia and Herzegovina convertible mark, fixed against the Deutsche Mark from 1998 until 2002. Fixed to the

thereafter. * British West African pound, fixed against the

from 1913 until 1964. * Ceylonese Rupee, fixed against the Indian silver rupee from 1884 until 1950. *

Irish pound The pound ( Irish: ) was the currency of Ireland until 2002. Its ISO 4217 code was IEP, and the symbol was £ (or £Ir for distinction.) The Irish pound was replaced by the euro on 1 January 1999. Euro currency did not begin circulation unti ...

, pegged against

from independence until 1979, issued by a currency board until 1942. *

East African shilling The East African shilling was the Pound sterling, sterling unit of account in British Empire, British-controlled areas of East Africa from 1921 until 1969. It was issued by the East African Currency Board. It is also the proposed name for a com ...

, fixed against the

from 1921 until 1969. *

East German mark The East German mark ( ), commonly called the eastern mark ( ) in West Germany and after German reunification, reunification, was the currency of the East Germany, German Democratic Republic (East Germany). Its ISO 4217, ISO 4217 currency code w ...

pegged to the West German mark. * Estonian kroon, fixed against the

from independence in 1992 until 1999. Fixed to the

thereafter until 2011. *

Lithuanian litas The Lithuanian litas (ISO 4217, ISO currency code LTL, symbolized as Lt; plural ''litai'' (nominative) or ''litų'' (genitive) was the currency of Lithuania, until 1 January 2015, when it was replaced by the euro. It was divided into 100 Cent ...

, fixed against the

US dollar The United States dollar (symbol: $; currency code: USD) is the official currency of the United States and several other countries. The Coinage Act of 1792 introduced the U.S. dollar at par with the Spanish silver dollar, divided it int ...

from 1994 until 2002. Fixed to the

thereafter until 2015 when the litas was replaced with the euro. * Philippine peso fixed to the 'milled dollar' during the Spanish and American colonial era, up until 1941. Pegged to the

Japanese yen The is the official currency of Japan. It is the third-most traded currency in the foreign exchange market, after the United States dollar and the euro. It is also widely used as a third reserve currency after the US dollar and the euro. Th ...

from 1942 to 1944. Post-independence, it was also pegged to the

from 1946 to 1959, and again from 1966 to 1983. * Thai baht initially fixed to

Pound sterling Sterling (symbol: £; currency code: GBP) is the currency of the United Kingdom and nine of its associated territories. The pound is the main unit of sterling, and the word '' pound'' is also used to refer to the British currency general ...

, and then the

until the Asian currency crisis

References

External links

Currency boards and dollarization (archived Web site)
* Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise, Currency Board Book Serie

Studies in Applied Economics working paper series (includes many papers on currency boards

and Digital Archive on Currency Board

{{DEFAULTSORT:Currency Board Currency, Board Monetary policy Government institutions