September 20, 1995
|Contact:||John Williamson||(202) 328-9000|
Washington, DCA currency board is an arrangement under which a country fixes its exchange rate and maintains 100 percent backing of its money supply with foreign exchange. The process has been making a comeback in recent years. Hong Kong adopted a currency board in 1983 and has been followed by Argentina, Estonia, and Lithuania. Some advocates have urged many other countries including Mexico, Russia, and Ukraine to follow suit. Senior Fellow John Williamson argues in his new study What Role for Currency Boards? that it would be a mistake for those countries to accept such advice.
Williamson agrees that currency boards have certain virtues. They assure convertibility, instill macroeconomic discipline that limits budget deficits and inflation, provide a mechanism that guarantees adjustment of balance-of-payments deficits, and thus create confidence in the country's monetary system. However, a currency board also carries a series of important disadvantages:
Since there are both important advantages and disadvantages in adopting a currency board in place of a central bank, it is to be expected that each arrangement will be preferable under some circumstances. Williamson identifies three situations where a currency board will be superior:
Applying the analysis to some of the countries that have recently been urged to adopt currency boards, Williamson argues that there is little ground for urging such a step on Mexico: it is not small, the monetary crisis was limited in the sense that the demand to hold pesos did not collapse, and it would be ill-advised to resort again to using the exchange rate as a nominal anchor. The case is slightly stronger in regard to Russia and Ukraine, where a currency board might have the benefit of inducing a quicker substitution of domestic for foreign money, but even in these cases a decision to give up the exchange rate instrument would be too much of a gamble in the longer term when it seems that the worst of the monetary crisis is already over.