What is the currency board system?
2023-06-19
Summary:
The establishment of a currency board system can effectively maintain the stability and credibility of a country's currency and ensure the healthy development of the economy.
The currency board system refers to the exchange rate regime in which the government explicitly stipulates in the form of legislation that the local currency can be freely exchanged with a certain foreign currency at a fixed rate and requires the monetary authority to ensure the realization of this exchange obligation.
It has two basic principles: firstly, the domestic currency is pegged to a strong currency to establish monetary relations with it, which becomes the anchor currency; secondly, the domestic currency's issuance is guaranteed by foreign exchange reserves, especially the foreign exchange reserves of the anchor currency, to ensure that the domestic currency and foreign currency can be exchanged at a fixed exchange rate at any time.
The responsibilities of the currency bureau system include monetary policy formulation, currency issuance, foreign exchange management, financial supervision, and other aspects. Monetary policy making is one of the most important responsibilities of the monetary bureau, which affects the economic operation by adjusting the money supply, interest rate level, and other means. Currency issuance means that the Monetary Bureau is responsible for issuing and managing the national currency to ensure that the money supply meets the needs of economic development. Foreign exchange management refers to the responsibility of the currency bureau to manage the country's foreign exchange reserves and maintain the balance of international payments. Financial regulation refers to the responsibility of the Monetary Authority to regulate financial institutions and maintain financial market stability.
Under the currency board system, the domestic currency is 100% supported by foreign currencies, and the currency issuing institution (whether it is the central bank or the government) determines a fixed exchange rate for this foreign currency and, at any time, at the request of the public, converts the domestic currency into foreign currency at this exchange rate. The currency board is an extension of the fixed exchange rate targeting system.
In the monetary bureau, the commitment to fixed exchange rates is particularly firm and reliable, as the implementation of monetary policy is automatically effective and completely out of the control of central banks and governments. On the contrary, the typical fixed or pegged exchange rate regime allows monetary authorities to make some judgments when implementing monetary policies because they can still adjust interest rates or print money under the monetary board system. Therefore, the monetary bureau arrangement has significant advantages over monetary policy strategies that only use exchange rate targeting: firstly, the money supply will only expand when foreign currency is converted into domestic currency at the central bank; secondly, the monetary bureau arrangement includes a stronger commitment from the central bank to maintain a fixed exchange rate, which may effectively reduce inflation quickly and reduce the probability of successful speculative shocks.
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