Currency board

A currency board is a monetary authority which is required to maintain an exchange rate with a foreign currency. This policy objective requires the conventional objectives of a central bank to be subordinated to the exchange rate target.

The currency board in question will no longer issue fiat money but instead will only issue one unit of local currency for each unit of foreign currency it has in its vault. 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. 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.

Hong Kong operates a currency board, as does Bulgaria. Estonia established a currency board pegged to the Deutschmark in 1992 after gaining independence, and this policy is seen as a mainstay of that country's subsequent economic success (see Economy of Estonia for a detailed description of the Estonian currency board). Argentina abandoned its currency board in January 2002 after a severe recession. This emphasised the fact that currency boards are not irrevocable, and hence may be abandoned in the face of speculation by foreign exchange traders.

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.

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.

COMPREHENSION

• Does a currency board perform all functions of a central bank?

• What advantages does this system have?

• Are there any drawbacks?

• What countries have and had currency boards?

• Is it effective to introduce a currency board system in big economies like Russia’s?

• Does a currency board relate in any way to inflation?

 Key Vocabulary

fiat money	бумажные деньги (не обеспеченные золотом)	Most of the world's paper money is fiat money.
unit of currency	денежная единица	The farthing was still a useful unit of currency and the coins of the time had a grace and beauty which have since disappeared.
surplus	зд. положительное сальдо (баланса)	The balance of payments surplus hit a new record.
deposit	депозит, вклад (в банке)	A deposit is a sum of money which is in a bank account.
money supply	денежная масса	To show how policy can be effective in this model we first consider the case in which the authorities simply set the money supply to be constant.
mainstay	перен. опора, оплот	In particular, it is a stunning blow for the Christian Democrats, mainstay of every Italian government since the war.
foreign exchange trader	валютный трейдер	The new system allows a foreign exchange trader or the like to listen in to some 20 phone conversations at once via a sophisticated touch screen.
commitment	обязательство	This commitment brings credibility to our social programmes.

READING SKILLS

• Skim the text and give the main idea.

• What is a managed float?

• Comment on the statement in italics.

A Managed Float

Under a free float there is no central bank intervention in the foreign exchange market. The foreign exchange reserves remain constant, the balance of payments is exactly zero, and the net monetary inflow from abroad is also zero.

In practice, exchange rates have rarely been allowed to float absolute freely during the period since 1973 when the Bretton Woods system of the adjustable peg was replaced by a floating exchange rate regime. In the short run, central banks intervene in the foreign exchange market both in an attempt to smooth out fluctuations in the exchange rate and, sometimes, in an effort to nudge the exchange rate in the direction in which the government would like to see it change.

Such intervention may help smooth out day-to-day exchange rate fluctuations, but in the long run it probably makes little difference to the path the exchange rate follows. Central banks have large stocks of foreign exchange reserves which they could dump on the foreign exchange market in an effort to alter the equilibrium exchange rate. But the speculators probably have even larger funds at their disposal. One argument for coordinating the central bank intervention in different countries is that, together, the central banks might then have sufficient funds to take on the speculators. Playing the foreign exchanges is not unlike playing poker: if all players are equally good, the player with the most money is very likely to win.

COMPREHENSION

• Were exchange rates allowed to freely float before the Bretton Woods system?

• Why do central banks intervene in foreign exchange markets?

• In what way do central banks use their foreign exchange reserves?

• What are coordinated central banks interventions?

 Key Vocabulary

managed float	управляемое плавание (валютного курса)	Managed float is often the first step towards free float of the currency.
free float	свободное плавание (валютного курса)	A system of free-floating rates was introduced after the reform had been implemented.
intervention	интервенция	But of course as far as Britain was concerned, this could only be intervention against France.
foreign exchange reserves	резервы иностранной валюты	That selective import controls would be necessary in the short term to protect foreign exchange reserves.
inflow	приток	The proposals are intended, in particular, to encourage the inflow of investment to the UK and address matters relevant to the current recession.
adjustable peg	корректируемая привязка	Another alternative is an adjustable peg arrangement under which exchange rates are fixed at agreed values, but revaluations and devaluations of currencies can be undertaken under certain conditions.
to intervene	вмешиваться; проводить интервенцию	In education, local government, and health the government has intervened and regulated on a large scale.
to smooth out fluctuations	сглаживать колебания	This move has smoothed out the minor fluctuations caused by the previous decision of the Cabinet.

EXERCISES