TOPIC 3.1 - Currency Boards Flashcards
What is a Currency Board?
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.
What is the main advantage of currency boards?
It restricts the role of the CB and lowers inflation.
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?
250 * 0.04 = $10B Therefore… it is a credible ER
If…
MS = 250B pesos Reserves(US$) = $10B ER = $1 = 20 pesos or ER = 1 pesos = $0.05
Is the ER credible under a currency board?
250 * 0.05 = $12.5B Therefore… the ER is not credible
Explain the flow chart regarding Capital inflows and the HKD ER stability
- Capital Inflow
- Market participants buy HKD
- Demand for HKD increase. Therefore Upward pressure on the HKD ER.
- Currency Board sells HKD
- Monetary Base Expands (MS increases)
- IR drops
Explain the flow chart regarding Capital outflows and the HKD ER stability
- Capital Outflow
- Market participants sell HKD
- Downward pressure on the HKD, due to increased supply
- Currency Board buys HKD
- Monetary Base contracts (MS decreases)
- IR increases
Draw the graphs that explain and link to the HKD ER stability flow chart.
See graphs in notebook
Examples of Currency Boards
USD:
Hong Kong
Argentina (now fixed)
Euro:
Bulgaria
Lithuania (now euro)
What type of Currency Board is backed by Gold instead of foreign currency?
Gold Standard
What are the three roles of a reserves currency?
International Unit of Account
International Medium of Exchange
International Store of Value
What are the advantages of a Currency Board?
Stable MP
Lower expected inflation
Govt can’t monetise fiscal deficits (print money)
Need to be completely credible
What is the disadvantage of a currency board?
Prone to large swings in S & D of currency therefore could be vulnerable to speculative attack if not credible.
What is the Hong Kong Monetary Authority?
It is a currency board, est in 1993
What are the main functions of the HKMA?
Stability of currency and financial system.
HK’s status as an international financial centre
Managing the Exchange Fund
What is the official foreign currency reserve of HK at the end of June 2022?
$447.3B USD which is over 6x the currency in circulation
When did Argentina operate a currency board and why?
Between 1991 - 2002
Because of hyper-inflation due to large fiscal deficits (G > T) and printing of money
What did Argentina set as its ER and what did this entail regarding reforms?
1 pesos = $1 USD
They had to reform their structure for example stop monetising budget deficits (printing money)
What happened to Argentina in late 2000s?
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
What happened in 2001 in Argentina?
Aim to balance budget
Dec they had defaulted on $100B worth of debt (largest sovereign default in history)
What happened to Argentina in 2002?
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.
What were the two main contributing factors to the Argentine collapse?
- Appreciation of USD and sharp fall in Brazil Real
- low international exports prices
Resulted:
US business cycle not same as Argentina.
Argentina’s labour market being relatively rigid.
Explain the ‘recovery’ of Argentina
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.
Three ways to keep a currency board credible…
- No printing money
- Balancing Budget
- Prudence in spending
