Currency Board
A currency board is a monetary regime that issues domestic currency only against foreign reserves, under a legal commitment to exchange it for a named anchor currency at a fixed rate. It gives up independent monetary policy in return for credibility.
Also called: currency board arrangement · CBA · currency board system
The IMF describes a currency board as an explicit legislative commitment to exchange the domestic currency for a specified foreign currency at a fixed rate, combined with limits on the issuing authority that make the promise enforceable. The monetary base is fully backed by foreign assets, so the board cannot lend freely to the government or act as an unlimited lender of last resort. When money flows out, the base shrinks and local interest rates rise automatically; when it flows in, the reverse happens.
Hong Kong's Linked Exchange Rate System, in place since 17 October 1983, is the best-known example, and the Hong Kong Monetary Authority describes it as a currency board system. The Hong Kong dollar is linked to the US dollar at HK$7.80 and kept within a range of HK$7.75 to 7.85, with the HKMA standing ready to buy or sell US dollars at the edges. Note-issuing banks must deliver US dollars to the HKMA at the linked rate in order to issue banknotes.
A currency board is the hardest form of peg short of dollarization. In the terms of the impossible trinity it chooses a fixed rate and an open capital account, and so imports the anchor country's interest rates whether or not they suit the local economy. For payment firms the attraction is predictable conversion; the regime is only as strong as the reserves and the political commitment behind it.
In practice
Real arrangements vary. Some boards hold reserves well above 100 percent of the base, some allow limited discretion, and a board created by statute can be changed by the same legislature.
Example
When the Hong Kong dollar weakens to HK$7.85 per US dollar, the HKMA sells US dollars and buys Hong Kong dollars from banks. Interbank liquidity shrinks and local interest rates rise until the outflow stops.
Learn more on Money Wiki
This page gives the short answer. Money Wiki has a longer guide to Currency Board, with more detail and background.
Commonly confused with
| Term | How it differs |
|---|---|
| Currency peg | A conventional peg is a policy the central bank can adjust at its discretion. A currency board writes the rate and the full reserve backing into law. |
See also
- Currency PegA currency peg is a policy under which a central bank fixes its currency's exchange rate to another currency or a basket and stands ready to buy and sell at that rate. The peg lasts only as long as the reserves and credibility behind it.
- Impossible TrinityThe impossible trinity holds that a country cannot have a fixed exchange rate, free movement of capital and an independent monetary policy all at once. It can choose any two, and giving up the third is the price of the other two.
- DollarizationDollarization is the use of a foreign currency, usually the US dollar, in place of or alongside a country's own for saving, pricing and payment. It can be official policy or something households and firms do on their own.
- Foreign Exchange ReservesForeign exchange reserves are the foreign-currency assets a central bank holds and can use at short notice: deposits and government securities in major currencies, gold, Special Drawing Rights and the country's reserve position at the IMF.
- Capital ControlsCapital controls are government limits on moving money into or out of a country, or on converting its currency at the official rate. Imposed by a central bank or finance ministry, they determine whether a payment corridor is workable at all, and in which direction.