TOPIC 3.1 - Currency Boards

Question 1

What is a Currency Board?

Answer 1

Fixed exchange rate regime
Country pegs their currency against a foreign currency.
ER is 100% backed by foreign currency reserves,
Either replaces or works alongside the CB.

Question 2

What is the main advantage of currency boards?

Answer 2

It restricts the role of the CB and lowers inflation.

Question 3

If …

MS = 250B pesos       
Reserves (US$) = $10B        
ER = $1 = 25 pesos  
OR    
ER = $0.04 = 1 pesos

Is the ER credible under a currency board regime?

Answer 3

250 * 0.04 = $10B Therefore… it is a credible ER

Question 4

If…

MS = 250B pesos Reserves(US$) = $10B ER = $1 = 20 pesos or ER = 1 pesos = $0.05

Is the ER credible under a currency board?

Answer 4

250 * 0.05 = $12.5B Therefore… the ER is not credible

Question 5

Explain the flow chart regarding Capital inflows and the HKD ER stability

Answer 5

1. Capital Inflow
2. Market participants buy HKD
3. Demand for HKD increase. Therefore Upward pressure on the HKD ER.
4. Currency Board sells HKD
5. Monetary Base Expands (MS increases)
6. IR drops

Question 6

Explain the flow chart regarding Capital outflows and the HKD ER stability

Answer 6

1. Capital Outflow
2. Market participants sell HKD
3. Downward pressure on the HKD, due to increased supply
4. Currency Board buys HKD
5. Monetary Base contracts (MS decreases)
6. IR increases

Question 7

Draw the graphs that explain and link to the HKD ER stability flow chart.

Answer 7

See graphs in notebook

Question 8

Examples of Currency Boards

Answer 8

USD:
Hong Kong
Argentina (now fixed)

Euro:
Bulgaria
Lithuania (now euro)

Question 9

What type of Currency Board is backed by Gold instead of foreign currency?

Answer 9

Gold Standard

Question 10

What are the three roles of a reserves currency?

Answer 10

International Unit of Account
International Medium of Exchange
International Store of Value

Question 11

What are the advantages of a Currency Board?

Answer 11

Stable MP
Lower expected inflation
Govt can’t monetise fiscal deficits (print money)
Need to be completely credible

Question 12

What is the disadvantage of a currency board?

Answer 12

Prone to large swings in S & D of currency therefore could be vulnerable to speculative attack if not credible.

Question 13

What is the Hong Kong Monetary Authority?

Answer 13

It is a currency board, est in 1993

Question 14

What are the main functions of the HKMA?

Answer 14

Stability of currency and financial system.
HK’s status as an international financial centre
Managing the Exchange Fund

Question 15

What is the official foreign currency reserve of HK at the end of June 2022?

Answer 15

$447.3B USD which is over 6x the currency in circulation

Question 16

When did Argentina operate a currency board and why?

Answer 16

Between 1991 - 2002

Because of hyper-inflation due to large fiscal deficits (G > T) and printing of money

Question 17

What did Argentina set as its ER and what did this entail regarding reforms?

Answer 17

1 pesos = $1 USD

They had to reform their structure for example stop monetising budget deficits (printing money)

Question 18

What happened to Argentina in late 2000s?

Answer 18

Weak fiscal position. Low tax revenues
Investors dumped the currency. 
Govt offered higher IR on govt bonds
However rising borrowing costs decreased I and C
Late Dec = food riots and demonstrations

Question 19

What happened in 2001 in Argentina?

Answer 19

Aim to balance budget

Dec they had defaulted on $100B worth of debt (largest sovereign default in history)

Question 20

What happened to Argentina in 2002?

Answer 20

Jan 2002:
Re-fix the peg to 1.4 pesos = 1 USD

Feb 2002:
Abandon the currency board pesos lost 75% of their value with respect to USD within months.

Question 21

What were the two main contributing factors to the Argentine collapse?

Answer 21

1. Appreciation of USD and sharp fall in Brazil Real
2. low international exports prices

Resulted:
US business cycle not same as Argentina.
Argentina’s labour market being relatively rigid.

Question 22

Explain the ‘recovery’ of Argentina

Answer 22

9% growth between 2003 -2006

• world growth
• competitive currency
• increased exports,
• 93% debt settlements

However, 7% won in court forcing Argentina to pay ball ALL debt.

Defaulted $20B worth of debt.

Question 23

Three ways to keep a currency board credible…

Answer 23

1. No printing money
2. Balancing Budget
3. Prudence in spending