Currency Board
AdvancedA currency board is a strict form of fixed exchange rate system in which a monetary authority is legally required to exchange domestic currency for a specified foreign currency at a fixed rate, and to back all domestic currency in issue with foreign reserves.
Under a currency board, the domestic money supply can only grow if foreign reserves grow. The authority cannot freely print money or lend to the government, which makes the peg highly credible.
Hong Kong has operated a currency board system linked to the US dollar since 1983. Several other economies have used currency boards, often to bring high inflation under control and build confidence in a new currency.
For example, a country with a history of hyperinflation might adopt a currency board linked to a stable currency, ensuring that every unit of local money is backed by foreign currency reserves.
The main advantages are credibility and low inflation. The disadvantages are the loss of independent monetary policy, since interest rates follow those of the anchor currency, and limited ability to act as a lender of last resort to banks. Argentina's currency board-like system collapsed in 2002, showing that even strict arrangements can fail if economic conditions become unsustainable.
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